Introduction to corporate governance
Summary articles
Article 1: Me or we: the effects of CEO organizational
identification on agency costs
Steven Boivie, Donald Lange, Michael L. McDonald, James D. Westphal
Corporate governance
Corporate governance = the way firms are directed and controlled
(Cadbury Committee, 1992). Corporate governance is important for:
The firm: better access to resources, lower cost of capital
Suppliers of finance: reduced risk of crisis and scandals, better firm
reputation
Society: better allocation of resources, more sustainable ways of
operating
Corporate governance research has long focused on external control
mechanisms such as the board of directors as remedies (oplossingen) for
the agency problem.
The role of internal, psychological actor has been underexplored. This
study integrates the agency theory and the organizational identification
theory to explain CEO behavior.
Agency theory
The agency theory is about the different interests of shareholders
(principles) and CEO’s (agents). CEO’s may pursue personal goals, such as
high compensations, which does not add value to the shareholders.
This could lead to agency problems. Examples of problems are differences
in goals, information asymmetry, complete contracts are impossible.
There are two basic forms of agency problems:
Adverse selection (ex ante)
Hidden information before the deal which can lead to the lemons
problem.
Moral hazard (ex post)
Agent may take actions that do not act in the best way for the
principal. For example: ‘big is beautiful’ but that does not always add
value to shareholders.
Or ‘company jet’: providing business asset, but using it mainly for
personal use.
Or ‘leisure consumption’: buying assets for only personal use
(vacation)
The traditional remedy for agency problems is an external mechanism: an
independent board of directors (raad van commissarissen) for example,
who monitors the agent.
The board of directors reduces information asymmetry and moral hazard
(by aligning the incentives of the CEO with the owner (shareholders)).
Organizational identification
,The organizational identification theory is about individuals that strongly
identify with an organization. They act in ways that benefit the
organizations, they derive self-esteem form the organization’s success and
want to protect its image, and they are less likely to distinguish between
personal interest and organizational interest.
The authors of the article argue that CEO organizational identification can
mitigate agency costs by changing the CEO’s motivations:
A CEO who strongly identifies with the firm sees its financial health
and reputation as extensions of their own self-esteem.
This reduces their inclination to pursue self-serving behaviors (high
pay, perks), because such behaviors damage the firm and thus the
CEO’s own self-concept.
Identification therefore functions as an internal governance
mechanism, a substitute for external monitoring.
Substitution effect
The substitution effect draws on social identity and social control theory. It
says something about the degree of need for other control mechanisms.
When identification with a group is strong, external controls has a weaker
effect, because the CEO already self-regulates. When identification is low,
external governance (such as board independence) becomes more
important.
,Article 2: Does Corporate Philanthropy Increase Firm Value? The
Moderating Role of Corporate Governance
Weichieh Su, Steve Sauerwald
Corporate philanthropy
Corporate philanthropy (CP) is a company’s voluntary act of donating
resources, such as money and goods. The relationship between corporate
philanthropy and firm value have long been discussed. There are two
perspectives:
1. Agency Theory
This perspective views CP as an agency cost. Managers may use CP to
serve their own self-interest (for example for status or reputation) rather
than creating value for shareholders.
Benefits of CP are often intangible and long-term, which makes it difficult
for shareholders to verify whether donations serve firms goals or reflect
managerial ego.
It has no clear monetary effect in the short run.
2. Strategic Resource View (resource-based view)
This perspective views CP as an opportunity for a strategic investment. If
aligned with firm goals, CP can create intangible assets, such as
reputation, trust, stronger stakeholder relationships and employee
satisfaction. These are valuable, rare and hard to copy which improves the
competitiveness and long-term firm value (=resource endowment).
Corporate governance mechanisms
Whether CP creates or destroys firm value depends on corporate
governance mechanisms. The mechanisms are aimed at influencing
behavior of the agent, the principal and other stakeholders. Traditionally
the focus was on creating value for the firm’s shareholder, currently the
focus is shifting to long-term value creation for stakeholders.
Internal CG mechanisms External CG mechanisms
Board of directors Auditors, advisors
Board committees Blockholders
Top management team Providers of debt
Work councils Market of corporate control
Management information systems Media
Incentive structure used to Financial analysts
motivate the agent
The authors argue that corporate governance mechanisms (CEO
compensation, board monitoring, CEO power) determine whether CP
creates long-term value for stakeholders or becomes wasteful spending.
Next some corporate mechanisms:
CEO long-term pay: paying CEO’s with stock options that vest over
several years. When CEO’s know their compensation depends on the
, company’s long-run performance, they are more likely to engage in CP
strategically.
-> in this case CP creates long-term value
Busy board: if directors sit on too many boards
(multiboard, busy board) they might be too busy
to monitor and give CEO’s room to misuse
philanthropy.
-> In this case CP becomes wasteful spending
CEO tenure (power): agency theory predicts long-tenured CEO’s misuse
CP, but surprisingly the study finds that experienced CEO’s actually use CP
more effectively, likely because they have strong firm-specific knowledge
and networks.
-> In this case CP creates long-term value
Summary articles
Article 1: Me or we: the effects of CEO organizational
identification on agency costs
Steven Boivie, Donald Lange, Michael L. McDonald, James D. Westphal
Corporate governance
Corporate governance = the way firms are directed and controlled
(Cadbury Committee, 1992). Corporate governance is important for:
The firm: better access to resources, lower cost of capital
Suppliers of finance: reduced risk of crisis and scandals, better firm
reputation
Society: better allocation of resources, more sustainable ways of
operating
Corporate governance research has long focused on external control
mechanisms such as the board of directors as remedies (oplossingen) for
the agency problem.
The role of internal, psychological actor has been underexplored. This
study integrates the agency theory and the organizational identification
theory to explain CEO behavior.
Agency theory
The agency theory is about the different interests of shareholders
(principles) and CEO’s (agents). CEO’s may pursue personal goals, such as
high compensations, which does not add value to the shareholders.
This could lead to agency problems. Examples of problems are differences
in goals, information asymmetry, complete contracts are impossible.
There are two basic forms of agency problems:
Adverse selection (ex ante)
Hidden information before the deal which can lead to the lemons
problem.
Moral hazard (ex post)
Agent may take actions that do not act in the best way for the
principal. For example: ‘big is beautiful’ but that does not always add
value to shareholders.
Or ‘company jet’: providing business asset, but using it mainly for
personal use.
Or ‘leisure consumption’: buying assets for only personal use
(vacation)
The traditional remedy for agency problems is an external mechanism: an
independent board of directors (raad van commissarissen) for example,
who monitors the agent.
The board of directors reduces information asymmetry and moral hazard
(by aligning the incentives of the CEO with the owner (shareholders)).
Organizational identification
,The organizational identification theory is about individuals that strongly
identify with an organization. They act in ways that benefit the
organizations, they derive self-esteem form the organization’s success and
want to protect its image, and they are less likely to distinguish between
personal interest and organizational interest.
The authors of the article argue that CEO organizational identification can
mitigate agency costs by changing the CEO’s motivations:
A CEO who strongly identifies with the firm sees its financial health
and reputation as extensions of their own self-esteem.
This reduces their inclination to pursue self-serving behaviors (high
pay, perks), because such behaviors damage the firm and thus the
CEO’s own self-concept.
Identification therefore functions as an internal governance
mechanism, a substitute for external monitoring.
Substitution effect
The substitution effect draws on social identity and social control theory. It
says something about the degree of need for other control mechanisms.
When identification with a group is strong, external controls has a weaker
effect, because the CEO already self-regulates. When identification is low,
external governance (such as board independence) becomes more
important.
,Article 2: Does Corporate Philanthropy Increase Firm Value? The
Moderating Role of Corporate Governance
Weichieh Su, Steve Sauerwald
Corporate philanthropy
Corporate philanthropy (CP) is a company’s voluntary act of donating
resources, such as money and goods. The relationship between corporate
philanthropy and firm value have long been discussed. There are two
perspectives:
1. Agency Theory
This perspective views CP as an agency cost. Managers may use CP to
serve their own self-interest (for example for status or reputation) rather
than creating value for shareholders.
Benefits of CP are often intangible and long-term, which makes it difficult
for shareholders to verify whether donations serve firms goals or reflect
managerial ego.
It has no clear monetary effect in the short run.
2. Strategic Resource View (resource-based view)
This perspective views CP as an opportunity for a strategic investment. If
aligned with firm goals, CP can create intangible assets, such as
reputation, trust, stronger stakeholder relationships and employee
satisfaction. These are valuable, rare and hard to copy which improves the
competitiveness and long-term firm value (=resource endowment).
Corporate governance mechanisms
Whether CP creates or destroys firm value depends on corporate
governance mechanisms. The mechanisms are aimed at influencing
behavior of the agent, the principal and other stakeholders. Traditionally
the focus was on creating value for the firm’s shareholder, currently the
focus is shifting to long-term value creation for stakeholders.
Internal CG mechanisms External CG mechanisms
Board of directors Auditors, advisors
Board committees Blockholders
Top management team Providers of debt
Work councils Market of corporate control
Management information systems Media
Incentive structure used to Financial analysts
motivate the agent
The authors argue that corporate governance mechanisms (CEO
compensation, board monitoring, CEO power) determine whether CP
creates long-term value for stakeholders or becomes wasteful spending.
Next some corporate mechanisms:
CEO long-term pay: paying CEO’s with stock options that vest over
several years. When CEO’s know their compensation depends on the
, company’s long-run performance, they are more likely to engage in CP
strategically.
-> in this case CP creates long-term value
Busy board: if directors sit on too many boards
(multiboard, busy board) they might be too busy
to monitor and give CEO’s room to misuse
philanthropy.
-> In this case CP becomes wasteful spending
CEO tenure (power): agency theory predicts long-tenured CEO’s misuse
CP, but surprisingly the study finds that experienced CEO’s actually use CP
more effectively, likely because they have strong firm-specific knowledge
and networks.
-> In this case CP creates long-term value
