WHAT CAN YOU LEARN FROM A BEHAVIORAL APPROACH TO CORPORATE GOVERNANCE? DEPARTMENT OF MANAGEMENT MIRIAM FLICKINGER AARHUS UNIVERSITY 9 NOVEMBER 2018 FULL PROFESSOR
AGENCY IN CORPORATE GOVERNANCE MONITORING PRACTICES System TOP MANAGERS Strategy Code CONTROL thics CORPORATE DIRECTORS E GOVERNANCE PERFORMANCE Shareholders Stakeholders Policies Transparency LAWS PROCEDURES DEPARTMENT OF MANAGEMENT MIRIAM FLICKINGER AARHUS UNIVERSITY 29 NOVEMBER 2018 FULL PROFESSOR
AGENCY IN CORPORATE GOVERNANCE OECD/European Central Bank Definition Corporate Governance • procedures and processes according to which an organization is directed MONITORING and controlled PRACTICES System • specifies the distribution of rights and responsibilities among the different participants in the organization – such as the board, managers, shareholders TOP MANAGERS Strategy and other stakeholders Code CONTROL • lays down the rules and procedures for decision-making. thics CORPORATE DIRECTORS E Agency in Corporate Governance GOVERNANCE • Economic/legal theories of governance rely on assumption of homo PERFORMANCE Shareholders economicus Stakeholders Policies Humans as self-interested agents who pursue their own utility in a Transparency LAWS rational way PROCEDURES • Basic system of Corporate Governance is agency-theoretic Managers act as agents for principals (=shareholders) Managers are incentivized to align their own utility with that of shareholders (Outside) directors are brought in to monitor actions of managers Fama & Jensen (1983), Jensen & Meckling (1976) DEPARTMENT OF MANAGEMENT MIRIAM FLICKINGER AARHUS UNIVERSITY 29 NOVEMBER 2018 FULL PROFESSOR
Your company has been operating on the premise that people — customers, employees, managers — make logical decisions. It’s time to abandon that assumption. Ariely, D. (2009:78). The end of rational economics DEPARTMENT OF MANAGEMENT MIRIAM FLICKINGER AARHUS UNIVERSITY 29 NOVEMBER 2018 FULL PROFESSOR
BEHAVIORAL GOVERNANCE: SOCIALLY SITUATED AND SOCIALLY CONSTITUTED AGENCY Social relationships Individual backgrounds networks experiences institutions Self-interested, agency- orientiented behavior of „ Socially „ Socially individuals situated “ constituted “ agency agency Westphal & Zajac (2013), Little (2012), Koo (2011) Socially constituted agency Socially situated agency Influence of prior socialization and other personal experiences Influence of the social environment on utility-maximizing or characteristics, e.g.: behavior, e.g.: Influence of social comparisons with other individuals Social influencing of others, e.g. interpersonal influence and/or groups (in-group bias) behavior or symbolic management Group-dynamic processes, e.g. pluralistic ignorance or Social learning through mimetic decision processes group polarization Norms of reciprocity, especially among the corporate elite Social identification Institutional logics and impression management DEPARTMENT OF MANAGEMENT MIRIAM FLICKINGER AARHUS UNIVERSITY 29 NOVEMBER 2018 FULL PROFESSOR
EXAMPLES AND RECOMMENDATIONS (1/2) Social Status social ranking and esteem Poorly performing CEOs can hold themselves in office accorded to an executive or board more easily: member in comparison to other When they have more status than the chairman of members of the corporate elite the board When there are fewer network outsiders on the CEO Poor board dismissal performance Flickinger, Wrage, Tuschke, & Bresser (2016) Recommendations: Firms should take into consideration a CEO’s social status when selecting supervisory board members: High-status CEOs should face a high-status Chairman of the Board to achieve a balance of power at the top Better corporate governance may be obtained if some board members are network outsiders and, thus, free from obligations toward the corporate elite DEPARTMENT OF MANAGEMENT MIRIAM FLICKINGER AARHUS UNIVERSITY 29 NOVEMBER 2018 FULL PROFESSOR
EXAMPLES (2/2) Overpayment Excess total CEO (+) Corporate compensation reputation Excess amounts of contentious elements (-) of CEO compensation Attention that CEOs incur: • Change in CEO (+) CEO tenure (-) • CEO age (-) • Schulz & Flickinger (2018) Recommendations: Firms should realize that stakeholder assessments of CEO compensation is not without consequences, nor does it occur in a rational, agency-oriented way The effect of excess CEO compensation on corporate reputation is especially strong when CEOs incur a lot of (media) attention. This should be taken into account when designing CEO pay packages DEPARTMENT OF MANAGEMENT MIRIAM FLICKINGER AARHUS UNIVERSITY 29 NOVEMBER 2018 FULL PROFESSOR
SUMMARY AND TAKE-AWAYS • Worldwide, corporate governance has moved little beyond the idea of individuals who voluntarily and rationally pursue their individual goals, guided by self-interest and personal risk preferences • This design is under-socialized and ignores socially-situated and socially-constituted elements of agency-behavior: Yes, individuals act in their own self-interest but they are not rational about it • Once we stop assuming that actors in corporate governance behave as rational utility- maximizers, we must question whether current systems encourage and incentive desired means and ends DEPARTMENT OF MANAGEMENT MIRIAM FLICKINGER AARHUS UNIVERSITY 29 NOVEMBER 2018 FULL PROFESSOR
HOW TO BE MORE RATIONAL Bias to check for What is this? What to do about it Self-interested biases Are decisions are made purely out of self-interest? Review the sitation with special care, especially for over-optism Affect heuristic Has anyone fallen in love with the problem or ist solution? Rigorously apply quality controls Groupthink Were there dissenting opinions and were they explored? Solicit dissenting views, discreetly if necessary Saliency bias Is the decision influenced by its similarity to a previous Ask for more analogies and compare them to the current situation situation? Confirmation bias Are credible alternatives included with the Request additional options recommendation? Availability bias What kind of information would you want to optimally Use checklists of the data needed for each kind of decision have? Anchoring bias Do you know where your numbers came from? Reanchor with figures from other models or request new analysis Halo effect Is there a wrong assumption of transferability? Eliminate false inferences, seek additional comparable examples Sunk-cost fallacy Are the decision makers overly attached to previous Consider the issue as if you were a new CEO decisions? Overconfidence Is the base case overly optimistic? Build a case taking an outside view Disaster neglect Is the worst case bad enough? Imagine that the worst has happened, and develop a story about why Loss aversion Is the decision overly cautious? Realign incentives to share responsibility for the risk or to remove risk Kahneman, Lovallo, & Sibony (2011) DEPARTMENT OF MANAGEMENT MIRIAM FLICKINGER AARHUS UNIVERSITY 29 NOVEMBER 2018 FULL PROFESSOR
SOURCES Ariely, D. (2009). The end of rational economics. Harvard Business Review. 87(7/8): 78-84. Fama, E.F., & Jensen, M.C. (1983). Separation of ownership and control. Journal of Law & Economics, 26(2): 301 – 326. Flickinger, M., Wrage, M., Tuschke, A., & Bresser, R. (2016). How CEOs protect themselves against dismissal: A social status perspective. Strategic Management Journal. 37(6): 1107-1117. Jensen, M.C. & Meckling, W.H. (1976). Theory of the firm: Managerial behavior, agency costs and ownership structure. Journal of Financial Economics. 3(4): 305 – 360. Kahneman, D., Lovallo, D., & Sibony , O. (2011). Before you make that big decision… Harvard Business Review. 89(6): 50 -60. Koo, J.-J. (2011). Understanding the social constitution of the human individual (unpublished Doctoral dissertation). University of Pittsburgh. Little, D. (2012). Explanatory autonomy and Coleman’s boat. Theoria. 74: 137 – 151. Schulz, A.-C. & Flickinger, M. (forthcoming). Does CEO (over)compensation influence corporate reputation? Review of Managerial Science. Westphal, J.D. & Zajac, E.J. (2013). A behavioral theory of corporate governance: Explicating the mechanisms of socially situated and socially constituted agency. Academy of Management Annals. 7(1): 607-661. DEPARTMENT OF MANAGEMENT MIRIAM FLICKINGER AARHUS UNIVERSITY 29 NOVEMBER 2018 FULL PROFESSOR
DEPARTMENT OF MANAGEMENT AARHUS UNIVERSITY
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