The Relationship between Corporate Governance and Innovative Strategies - Coursework Example

CORPORATE GOVERNANCE: INNOVATIVE STRATEGIES Abstract Despite the best efforts of academics and regulators alike, issues in corporate governance continue to manifest themselves in the worst ways possible. From the destructive fraud at WorldCom to recent frauds involving hedge funds, from the UK, United States to the Satyam episodes in India, failures of corporate governance have continued to lead to periodic episodes of fraud on a staggering scale. This paper attempts to understand the mechanisms underlying the relationship between corporate governance and innovative strategies through extensive research of available literature on the topic Corporate Governance: Innovative Strategies Introduction Corporate governance is simply a term used for the way that companies (corporate) are run and operated (governed). As stated by Colley et al. (2004) there have been a number of definitions for corporate governance, though, it implies as a misunderstanding of companies and the procedures practiced for the assurance of business proceedings preventing the benefit of involved groups such as the investors. It characteristically centers to alleviate the agency predicaments which may occur whilst possession and administration of the business is divided. Such problems can be diminished by means of numerous measures like the internal controls, oversight of administration or boardroom, regulatory oversight, compensation and incentive arrangements and external audits. (Segrestin & Hatchuel, 2008) According to Vinten (2004) corporate governance relies upon administrative functioning and the concern of communal accountability, the socio-cultural and ecological aspect of corporation practice, and authorized and moral exercises concerning the investors, consumers and shareholders of corporations. Comprehending the inference of corporate governance seems to increase significance amid transnational workforce, policy makers, industrialists, stakeholders and associated businesses. On a worldwide level, drive in the direction of incorporated commercial procedures and a free economy is being made available through globalization. Local organizations require competition with multinational firms in such situations. Corporate governance points towards the strategies and course of actions practiced by the corporations for achieving positive purposes, business goals and visions regarding investors, workers, patrons, dealers and various regulatory interventions and the society in general. The function of corporate governance is to make best use of investors' prosperity beside endeavors to attain proper profits for them. By itself, corporate governance bears propositions for the corporate communal accountability of corporations. (Collin, 2007) Theoretical Perspectives According to North (1990), institutions are structured out of the humanly restraints that occur as a result of the human interactions. Organizations present the regulations of the game, developed by civilizations to form order and institutions are the players that are restricted by these rules. Moreover, as expressed by Meyer and Nguyen (2005); and Wan (2005) that the impacts of the perspective contiguous organizations are underlined by the institutional perceptions, that forms their conduct. Meyer (2004) elucidates that most of the corporate governance theories are observed and developed from the industrial and organizational economies and structures as expressed by. Nonetheless, in terms of organizational development and progress, in various models there are significant variations. That there is a need to judge the scope to which presumptions developed from stratagem in developed economies are suitable to various organizational environments, for trade tactic study to make an enduring contribution. Since the development of international trade, corporate governance has been considered as an essential element of any firm’s conduct so that the corporate and economic expansion could be gauged to a desirable level of precision. The measures taken by investors to assure themselves of returns against their investments in certain corporations, forms the notion corporate governance. (Wright et al., 2005) Agency Theory The agency theory actually refers to the issues of the relationship that exist when there is a defined relationship between the two i.e. a principle and the agent. An agency relationship is said to exist when a principle delegates decision, authority or work on his behalf to the agent. The problems of agency occurs when the actions or intention of the agent and the principle are dissimilar. The fundamental assumption of the agency theory is this that the agents act rationally and are risk adverse and self- interested individuals. There are usually two problems that may occur in an agency relationship. Firstly it can be the insufficient monitoring by the principle of the agent that whether he has behaved in the way he was instructed or not and secondly it is the distribution of risk when both of them turn out to have different opinions towards risk. The relationship between the shareholders (principles) and the top management of the company i.e. the Board of Directors (agents) is an archetypal example of the agency relationship. Agency relationship emphasizes that as to how to manage the control of this relationship effectively. Firstly the agency theory illustrates that through information systems the self interests of the agents can be well monitored, therefore the formal systems applied within the firms such as the managerial reporting, budgeting systems and other sources of information i.e. for example the management surveillance and observation are the examples of the controls for management’s monitoring. In addition, the agency theory explains that all or most of the controls systems (discussed above) turn out to better define the scope or outline of the agents authority and precisely aligns them with the organizational objectives (Leong Ho, 2005). Shareholders Theory As discussed by O’Sullivan (2000) the supporters of the shareholder theory argue that, even though the shareholders rely on others for the effective running of the company, the shareholders are the ones in whose interests the corporations should be run i.e. to maximize shareholders wealth, as they are the principles. However, it is argued, that when corporations tend to maximized there shareholders wealth, it is not possible that only the shareholder wealth itself is only enhanced but also the performance of the entire economic system is also improved. They further explain that the retained earnings after interest and tax are the rewards for the shareholders for how they have behaved i.e. the reward for the waiting and the risk taking. It is commonly accepted not only in the financial economics but also in almost all of the majority economics that shareholders are appropriately unrestricted for the residual profits for corporate entity as they are the residual risk holders. It is further argued that the equity or the ordinary shareholders are the ones, who without any guarantee or without any contractual agreement for returns, alone acts economically and invest in the firms. Therefore as the residual profit takers, the shareholders have concerns of allotting their funds to different options to make the profits as much as possible, as they bear the risk that the corporation will make losses or profits. (O’Sullivan, 2000) Stakeholders Theory According to the contract theory it has been argued that sufficient importance should be placed to the interests of all stakeholders (bargain power holders). However, the stakeholder theory further expands this view to a broader spectrum. They explain that it is due to the attitudes of the society members that the prosperity and survival of a corporation are continued; therefore a corporation must not ignore its social and communal responsibilities towards the society and must perform it s operations in a way that if not brings benefits to the whole society, must abstain from practices that brings disadvantages to the society as a whole. It is further expressed that due to the decisive power of the society that a corporation could survive without abiding by it responsibilities to the society and even if it does it unpopularity might lead it to its end. (Wei, 2003) This research paper will be prepared on the principles of the definitions and explanations of corporate governance and the association between innovation and corporate governance. It is common to almost all of the various definitions of corporate governance that it refers to the controlling and managing of corporation’s practices (HIH Royal Commission 2003, Standard Australia 2004, Solomon 2007 and ANAO 1999). Although this concept of control was initially meant for the protection of the investment of the shareholders in companies, however, the independence of the corporation invention process might be affected by this notion. There are several theories such as shareholder theory and agency and stockholder theories that have illustrated the link between innovation and corporate governance in different ways. As explained by Hopkins (2002) in his example of agency theory that it is quite common to almost every single corporation that how the conflicting and rather infamous ways of corporate governance strategies are being introduced by the different owners depending on their competence. The influences on the corporate innovation strategies due to an independent external board member and an internal board member are examined. He summarized that it is not surprising that investors belonging to different backgrounds tend to have different inclinations for the corporate governance strategies (p.17) According to a recent study done empirically and theoretically it is explained that how the antitakeover regulations have influenced the market of corporate management, compensation contracts interact to affect innovations by firms and monitoring intensity that affects manager’s private control benefits (Sapra et al., 2008). Corporate Governance and Innovative Strategy Inadequate governance mechanisms can lead managers to pursue inappropriate strategies. Managers and owners may have different risk-return preferences. If owners can monitor managers perfectly, manger can be induced to pursue strategies consistent with the interests of owners. (David, 2006) Innovation is widely accepted as critical to the dynamic of wealth creation. Corporate strategy decisions involve choices of resource commitments to types of innovation, and such decisions place innovation squarely in the realm of corporate governance. Even so, there is a paucity of literature addressing the relationship of governance to innovative outcomes of the firm. Within the domains of economics and management, innovation is generally acknowledged as critical to the dynamic of wealth creation in competitive, market-based economics (Ven de Ven, 2006), and is a central theme of corporate strategy and competitive advantage. Research on innovation highlights the importance of corporate enterprises as institutions of innovation. (O’Sullivan, 2000) In the context of strategy decisions, innovation can be framed as a core concept of choices among possible resource commitments (Hoskisson, Hitt, Johnson, and Grossman, 2002). Strategy formulation figures prominently in corporate governance, placing innovation squarely in the governance realm, yet there is a paucity of literature that addresses the relationship of governance to innovative outcomes. Research of corporate governance has assumed a divergence of interests and risk profile between management and investors in firms with diffused shareholders. This divergence creates an agency problem manifested in the propensity of managers to pursue agendas that may be at odds with shareholders interests and preferences, including less investment in research and development (Amihud & Lev, 1981; Demsetz, 2003; Hill & Snell, 1989; Hoskisson &Turk, 2000). While some empirical evidence has substantiated the relationship of governance to innovative inputs, measured by constructs based on research and development spending (David, Hitt, & Gimeno, 2001; Hill & Snell, 1989), there is scant evidence regarding the relationship of corporate governance to the resulting productivity of those inputs, namely the innovative output of the firm. Innovative Strategies Prior research on corporate innovation suggests that managers may invest less in innovation if not constrained by strong governance mechanisms. Stock concentration in firms has been found to be positively related to innovation, suggesting that powerful shareholders may induce managers to invest in innovation (Hill & Snell, 1988). Also Barring one study (Greve, 2003; Kogut & Zander, 2003) found a positive association between institutional ownership and innovation, suggesting that institutional owners strongly encourage managers to invest in innovation. R & D expenditure is a commonly used as a proxy for investment in innovation. This measure may not be a good indicator of innovation because it is possible that firms may have the same level of R & D expenditure, yet differ in innovation ability because these resources are not managed efficiently (Bertrand & Schoar, 2003). Also, R & D expenditure could be indicative of retention of surplus funds within the firm instead of disturbing them to shareholders (Vinten, 2004), suggesting that R & D expenditure could indicate a greater level of agency costs (Cremers & Nair, 2005). It has been suggested that more direct measures of outcomes of innovation, such as the number of new products developed by the firm, may be a better measure of innovation (Doidge et al., 2009; Hoskisson & Turk, 2000). A higher number of new products reflects superior innovative ability and has been found to be associated with firm value (Lemmon & Lins, 2003). They found that ownership by pressure-resistant institutions (institutions that do not have business relationships with the firm) is positively associated with the number of new products introduced, while other institutions have no effect. Thus, firms with poor internal governance systems are likely to be less innovative. They are likely to invest less in R & D and as a consequence, have fewer new product announcements. Institutional investors are likely to be dissatisfied with these firms, and accordingly, target such firms for activism. CEO Power and Attributes CEOs have the most powerful voice in a corporation. Boards of director hire CEOs to maximize shareholder’s wealth. However, CEOs have interests that differ from share holders and can use their decision making authority within the corporation to promote their own interests over those of shareholders. Therefore, boards of directors will design a CEO’s contract and compensation with an eye on keeping the CEO’s attention on maximizing firm value (Musa, 2008). Firm’s innovation is not motivated by maximization of shareholder wealth but is associated with CEO compensation increases. (Lehn & Zhao, 2006) Conclusion Innovation is a central theme in wealth creation in market-based economies, and corporate entities are key actors in the dynamic that produces innovation. The governance of corporations includes oversight or influence of strategic decisions relative to commitments to investments in resources that have potentially innovative outcomes. The relationship of corporate governance to inventive outcomes is important to both research and practice. This study provides simply theoretical evidence attained through research that such an association exists and the shareholders rights are associated with the quantity and quality of inventive output of firms. References Amihud, Y. & Lev, B. (1981) Risk Reduction as a Managerial Motive for Conglomerate Mergers, Bell Journal of Economics, 12: 605-617 Bertrand, M. & Schoar, A. (2003) ‘Managing with Style the Effect of Managers on Firm Policies’, Quarterly Journal of Economics, 118(4), 1169.1208 Colley, J. L., Doyle, J. L., & Logan, G. (2004).What is Corporate Governance? McGraw-Hill Companies, pp. 2-3 Collin, S. (2007) ‘Governance Strategy: A Property Right Approach Turning Governance into Action’, Journal of Managerial Governance, 11:215-237 Cremers, K. J. M., & Nair,V. B. (2005) ‘Governance Mechanisms and Equity Prices’, Journal of Finance, 60(6), 2859.2894 David, P. (2006) ‘Corporate Governance, Strategy and Performance: Antecedents and Consequences of Activism by Institutional Investors’, Dissertation Abstracts International. David, P., Hitt, M. & Gimeno, J. (2001). ‘The Influence of Activism by Institutional Investors on R&D’, Academy of Management Journal, 44 (1) Demsetz, H. (2003) ‘the Structure of Ownership and Theory of the Firm’, Journal of Law and Economics, 26: 387-389 Doidge, C. G., Andrew, Lins, K. V., & Rene M. S. (2009) ‘Private Benefits of Control, Ownership, and the Cross-listing Decision’, Journal of Finance 64, 425-466 Greve, H. R. (2003) “A Behavioral Theory of R & D expenditures and Innovations: Evidence from Shipbuilding’. Academy of Management Journal, 46(6): 685-702 Hill, C. W. L. & Snell, S. A. (1989) ‘Effects of Ownership and Control on Corporate Productivity, Academy of Management Journal, 32(1): 25-46 Hoskisson, R. E., Hitt, M. A. Johnson, R. A. & Grossman, W. (2002) ‘Conflicting Voices: The Effects of Institutional Ownership Heterogeneity and Internal Governance on Corporate Innovation Strategies’. Academy of Management Journal, 45(4) Hoskisson, R. E. & Turk, T. A. (2000) “Corporate Restructuring: Governance and Control Limits of the Internal Capital Market’. Academy of Management Review, 15(3) Kogut, B. & Zander, U. (2003) ‘Knowledge of the Firm and the Evolutionary Theory of the Multinational Corporation’, Journal of International Business Studies, 34: 516-529 Lehn, K. & Zhao, M. (2006) ‘CEO Turnover after Acquisitions: Are Bad Bidders Fired?’ Journal of Finance 61(4): 1759-1811 Lemmon, M. L., & Lins, K. V. (2003) ‘Ownership Structure, Corporate Governance, and Firm Value: Evidence from the East Asian Financial Crisis, Journal of Finance 58, 1445-1468 Leong Ho, K. (2005) Reforming Corporate Governance in Southeast Asia: Economics, Politics, and Regulations, Institute of Southeast Asian Studies, pp. 354-355 Meyer, K. 2004. ‘Stakeholder Influence and Radical Change: A Coordination Game Perspective’, Asia Pacific Journal of Management 21: 235-253 Meyer, K. E., Nguyen, H.V. (2005) ‘Foreign Investment Strategies and Sub-National Institutions in Emerging Markets: Evidence from Vietnam. Journal of Management Studies 42(1): 63-93 Musa, M. A., Ismail, S. E. & Othman, S. ‘Corporate Governance and Innovative Leaders’ North, D. C. (1990) Institutions, Institutional Change, and Economic Preference, Norton: New York O’Sullivan, M. (2000) Contests for Corporate Control: Corporate Governance and Economic Performance in the United States and Germany, Oxford University Press, pp. 41-43 O’Sullivan, M. (2000) ‘The Innovative Enterprise and Corporate Governance’, Cambridge Journal of Economics, 24: 393-416 Sapra, H., Subramanian, A. & Subramanian, K. (2008) ‘Corporate Governance and Innovation: Theory and Evidence. Segrestin, B. & Hatchuel, A. (2008) ‘The Shortcomings Of The Corporate Standard: Towards New Enterprise Frameworks?’, International Review of Applied Economics, 22, (4): 429–445 Ven de Ven, A. H. (2006) ‘Central Problems in the Management of Innovation, Management Science, 32 (5): 366-457 Vinten, G. (2004) Corporate Governance: Corporate Mandate, Emerald Group Publishing Limited, pp. 84-87 Wan, W.P. (2005) ‘Country Resource Environments, Firm Capabilities, and Corporate Diversification Strategies’, Journal of Management Studies 42(1): 161-182 Wei, Y. (2003) Comparative Corporate Governance: A Chinese Perspective, Kluwer Law International, pp. 44-45 Wright, M., Filatotchev, I., Hoskisson, R.E. & Peng, M.W. (2005) ‘Strategy Research in Emerging Economies: Challenging the conventional wisdom’. Journal of Management Studies 42(1):1-33 Read More