There are two ideas that underlie most theories about corporate governance, and those reflect the assumptions of the classical economic theory of homo economicus, or economic man (or, more politically correctly, economic person). Economic man encapsulates two assumptions about human behaviour, i.e., that human beings always act in ways that are both rational and self-interested. While these assumptions are the bedrock of most classical and liberal economics, they have only recently begun to be tested empirically in the fields of behavioral economics and behavioral ethics. As I wrote in my 2011 article in Compliance and Ethics Professional, the empirical examination of rational self-interest has exposed some substantial faults in these assumptions. What has not yet happened, as far as I can see, is for these insights about human behaviour to be propogated to the study of corporate governance.
There are two primary theories of corporate governance, the shareholder/agency theory and the stakeholder theory. Each makes different moral assumptions about the purpose of the corporation and the ethical and practical responsibilities of the senior-most decision makers in the corporate structure, the board of directors. The agency theory is more representative of the Friedmanite view that the sole responsibility of the corporation is to maximise legal returns to shareholders. Stakeholder theory holds that society gives the corporation its license to operate and therefore there are other groups, or stakeholders, to whom are owed consideration in addition to shareholders. Examples of these stakeholders are customers, workers, suppliers, communities, and society at large as representative of common/societal goods, such as the environment.
What both both these theories have in common, however, is that they both view the actors within the corporate system as self-interested and rational. In fact, agency theory is a direct expression of the assumption of selfishness. It suggests that because management and ownership are separated, the agent (the manager) will be motivated to behave in his or her best interest, not in the best interest of the principle (the shareholders/owners). Without the assumption of selfishness, the principle/agent problem disappears (or is at least diluted). This in turn calls into question many of the incentives used to align shareholder interests with those of the management (stock options, restricted stock, and contingent bonus plans). Much of the research done into employee motivation suggests that, beyond a certain minimal level, compensation is one of the least effective motivators of employee performance. This thus provides an ex post facto indictment of the belief in the centrality of selfishness for corporate governance.
While stakeholder theory demotes the importance of self-consideration, it places a greater emphasis on rationality. In fact, it requires an assumption quite the reverse of selfishness, in that assumes that managers and/or corporate boards can place their own self-interest in abeyance and, without bias, consider the interest of other actors. Prominent researchers (Kahneman, Tenbrunesel, Messick) have empirically demonstrated several varieties of self-interested decision-making bias. Perhaps even more consequentially, these biases are usually unconscious and/or self-deceptive, so the decision-maker doesn’t know he or she acting in a self-interested way, even when the entire project of stakeholder consideration is to combat narrow self-interest.
The practical implication of the outdated assumptions of both agency and stakeholder theories is that there can be a substantial mismatch between the intentions of corporate board, the decisions that boards make, and subsequent behaviour of management. At the very least, new systems of remuneration and incentives need to be developed to align corporate direction with management activity. Additionally, when incorporating a stakeholder approach to corporate governance, it is important to verify the interests of other stakeholders with those stakeholders themselves as self-interest biases can yield incorrect assessments in this regard. There are considerable opportunities in both academic and practitioner realms for the development of new, comprehensive theories of corporate governance and practical frameworks to control for bias and diverse motivations.
Capital and Conscience 