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July 23, 2006
Welcome to The Spiral Path
Welcome!
I am pleased to let you know this blog has a new name - The Spiral Path
chriscurnow.com has been going through a revamp over the last few months. You may have notice that typing chriiscunow.com into your browser took you to a website about me. I am pleased about that, but it left this blog without a real name of its own.
So, after many nights tossing and turning, it has a new name.
Why The Spiral Path? The answer is here. I hope you like the new format.
You can always leave a comment!!!!
Posted by chriscurnow at 5:44 PM | Comments (0)
July 16, 2006
Agency Theory and Shareholder Value
At the complete opposite end of the spectrum from the warm and fuzzy Stakeholder Theory and Corporate Social Responsibility are the cold hard Agency Theory and ‘Shareholder Value’ approaches
Agency Theory
Agency theory first arose in the 1970s and was apparently developed by Ross (1973), Mitnick (1973) [10] and Jensen & Meckling (1976, as cited in Eisenhardt 1989) [11]. Eisenhardt describes it:
"Specifically, agency theory is directed at the ubiquitous relationship, in which one party (the principal) delegates work to another (the agent), who performs that work. Agency theory attempts to describe this relationship using the metaphor of a contract." (Eisenhardt, 1989:58).
Agency theory talks about two agency problems. 1) There is likely to be a conflict between the interests and goals of managers and principals and 2) managers and principals will have different levels of risk aversion. The costs of agency are said to be the cost to principals of 1) obtaining information about what managers are actually doing and 2) enticing managers to act in the interests of the principal.
Agency theory is both based on self interest (the agent will act in their own interests and against those of the principal) and relies on self interest in part to resolve this problem (different levels of incentive based on the self interest of the agent are required to motivate the agent to act according to the principal’s wishes).
This emphasis on self-interest causes concern for many of the theory's detractors. According to Eisenhardt (1989), "Perrow (1986) also criticized the theory for being unrealistically one-sided because of its neglect of potential exploitation of workers." and Mintzberg et al argue that the promulgation of this theory through business schools as contributing to a wider social phenomenon of selfishness:
The fabrication of economic man drives a wedge of distrust into society between our individual wants and our social needs. (Mintzberg et al, 2002). [12]
Shareholder Value
If you've read anything in the business press over the last 20 years, you would know that every board and senior executive has but one goal and responsibility - to increase 'Shareholder Value.' Regarding this concept, Sally Eastoe observes:
The term ‘shareholder value’ was first introduced in the 1980s by US consultants who were selling value-based management to companies already under stock-market pressure to increase returns. (Eastoe, 2005: 33) [13]
If you really want to undestand where this idea came from, you need to look at Lazonick and O’Sullivan (I'll mostly refer to them as L&O from now on) trace the phenomenon back to the 1980s when “a relatively small number of giant corporations … dominated the economy of the United States” (Lazonick & O’Sullivan, 2000: 14). Accumulating huge revenues these corporations allocated them according to a principle L&O call “retain and reinvest”. The corporations tended to “retain both the money that they earned and the people whom they employed.” (Ibid.) According to L&O this enabled them to build a strong foundation for growth. However, they argue, this principle began to run into problems because of the sheer size of the organisations they had built and competition — mainly from Japan at that time. Noting the rise of agency theory at this time and the
relatively poor performance of companies in the 1970s, agency theorists argued that there was a need for a takeover market…. The rate of return on corporate stock was their measure of superior performance, and the maximization of shareholder value became their creed. (Ibid: 16)
In parallel with the agency theorists during the 1970s “the institutional investor” (look up Jonk Bonds) also became prominent at this time, resulting in the “transfer of stockholding from individual households to institutions such as mutual funds, pension funds and life insurance companies. (Ibid.) [14] L&O trace how these developments, including the development of the junk bond market which facilitated launching hostile takeovers, led to a new paradigm — “downsize and distribute”
Finally, L&O argue that while it appears that a focus on shareholder value has paid off (at least for US shareholders)
We must consider the possibility that the US stock-market boom is encouraging US households to live off the past while corporations have less incentive to invest for the future. (Ibid. 32)
and
Yet the stock-market boom has not made capital available to industry. The persistent and massive flow of funds into stock-based mutual funds in the 1990s has bid up stock prices, increasing the market capitalizations of corporations. But, as we have seen, net corporate equity issues have been negative over the course of the 1990s because of corporate stock repurchases, while the main impact of the stock-market boom on capital markets has been to raise consumption. (Ibid.)
This suggests that the focus on shareholder value has not achieved the results suggested by its proponents at the macro level. In a future post, I am going to discuss Sally Eastoe’s Swinburne DBA thesis. Sally makes a strong argument that it does not produce results at the individual corporation level either.
I argue that something else is needed, and has always been needed, to develop commercial enterprise that is truly wealth creating over the long term. I suggest that what we need is an enduring purpose.
Posted by chriscurnow at 12:12 PM | Comments (0)
July 9, 2006
Origins of CSR and Stakeholder Theory
Origins and development of Corporate Social Responsibility and Stakeholder Theory
I've wondered for a long time how the belief in Shareholder Value came to dominate corporate thinking. I started reading around this topic to try to understand how this came to be. Clearly it is related to what each of us see as the purpose of corporations.
In a previous post, I wrote about Art Kleiner’s ‘Age of corporate dominance’. We’ve been arguing about the purpose of corporations ever since.. Do they exist solely to make a profit and serve their shareholder owners or do they have a social responsibility to other stakeholders as well?
In 1979, A.B.Carroll wrote:
The modern era of social responsibility, however, may be marked by Howard R. Bowen’s 1953 publication of Social Responsibility of the Businessman, considered by many to be the first definitive book on the subject É By the mid-1950s, discussions of the social responsibilities of businesses had become so widespread that Peter Drucker chided businessmen: “You might wonder, if you were a consciencious newspaper reader, when the managers of American business had any time for business” (p 497)
Stakeholder Theory came into being a decade later. Freeman & Reed suggest the term ‘stakeholder’ was “coined in an internal memorandum at the Stanford Research Institute in 1963” while they trace discussions of the social responsibilities of the modern corporation back to Berle and Means in 1932 who “were worried about the ‘degree of prominence entitling (the corporation) to be dealt with as a major social institution.’” and
Chester Barnard [who] argued that the purpose of the corporation was to serve society, and that the function of the executive was to instil this sense of moral purpose in the corporation’s employees. (Ibid.)
They note that Igor Ansoff included a discussion of the new [stakeholder theory] concept in his 1965 book, commented that systems theorists “led by Russell Ackoff ‘rediscovered’ stakeholder analysis” in the mid-1970s and in 1975 Dill “sought to move the stakeholder concept form the periphery of corporate planning to a central place.” (Freeman & Reed, again)
By the mid 1970s the term “corporate social responsibility” had come into common use (eg Sethi in 1975) and was used to cover the same ground as stakeholder theory. Also by this time, issues of definition and the terms meaning different things to different people had come into play:
The phrase corporate social responsibility has been used in so many different contexts that it has lost all meaning. Devoid of an internal structure and content, it has come to mean all things to all people. Business executives, academic scholars, government regulators, and social activists view the corporation's social role within their respective frames of reference, thereby allowing the evaluator maximum discretion as to the amount of funds expended, the nature of the activities engaged in, and the types of groups whose needs are responded to. (Sethi)
Indeed Sethi represents an early attempt to resolve this divergence of views by introducing the concept Corporate Social Performance. Carroll takes this further by developing a three-dimensional model in which Corporate Social Performance (CSP) is based on both Corporate Social Responsibility (CSR1) and Corporate Social Responsiveness (CSR2)
Throughout this phase, an important distinction began to develop. As Mitchell et al note
In 1978 William C. Frederick observed that business and society scholarship was in transition from a moral focus on social responsibility (CSR1) to an amoral focus on social responsiveness (CSR2). When stakeholder theory focuses only on issues of legitimacy, it acquires the fuzzy moral flavor of CSR1. Focusing only on stakeholder power, however, as several major organizational theories would lead us to do, yields the amorality and self-interested action focus of CSR2. Instead we propose a merger.
That is, some scholars and practitioners began promoting the view that business had to take stakeholders into account, not for any moral responsibility they had to these stakeholders, but rather because they had to manage the risk to the firm due to the influence activist group now had the power to exercise. Social performance was seen as a way of demonstrating the company’s responsiveness to social trends.
It was in this context that Freeman & Reed made an attempt to resolve these dilemmas in part by focusing on the political nature of stakeholder power and its implications for corporate governance:
We have hesitated to suggest particular strategies for directors that find themselves in one of the conflict situations we have explored. Our goal has been, rather, to counterbalance the great weight of attention expended on changing the (perceived) status quo and mandating certain types of board structure of behavior with attention placed on a realistic appraisal of the current situation and a sensitive elaboration of the potential lines of action currently available.
In other words, there is no simple formula that managers or directors can apply to determining what they need to do. Rather they have to exercise their judgment in each situation and on each issue.
As noted above, Mitchell et al (1997) made an important contribution in this phase as well. In Corporate Social Responsibility (and its derivatives — CSR2 and CSP) the question had been around whether to take a wide or narrow view of a corporation’s responsibilities (ie did they extend beyond economic and legal?) while in stakeholder theory there was a similar dilemma regarding the definition of ‘stakeholder’. The business rationalists defined stakeholder narrowly as ‘stockholder’ while other views include
The Narrow Sense of Stakeholder: Any identifiable group or individual on which the organization is dependent for its continued survival. (Freeman & Reed,)
and
The Wide Sense of Stakeholder Any identifiable group or individual who can affect the achievement of an organization’s objectives or whi is affected by the achievement of an organization’s objectives. (Freeman & Reed)
Mitchell et al’s contribution was twofold. First they attempted to answer the questions “Who is a stakeholder and what is at stake?” (Mitchell et al, 1997) by identifying stakeholders and their influence along the dimensions of Power; Legitimacy, Urgency and Salience. Secondly they make the important call for
empirical research that answers these questions: Are present descriptions of stakeholder attributes adequate? Do the inferences we make herein hold when examining real stakeholder-manager relationships? Are there models off interrelationships among the variables identified (and possible others) that reveal more subtle, but perhaps more basic, systematics? (Ibid.)
Unfortunately, it appears their call for empirical research in this area has largely gone unheeded.
Clarkson claims to present results from a 10 year research program but rather presents conclusions without data and, at best, sketchy details of his methodology.
Jones (1995) cites studies by Alexander and Buchman (1978), Cochran & Wood (1984) and Sturdivant & Ginter (1977) but concludes “none has been based on a credible theory.”
In my next post in this series, I will look at the origins of Agency Theory and Shareholder Value.
Posted by chriscurnow at 10:00 AM | Comments (0)
July 4, 2006
A brief history of the corporation
I've been thinking a lot lately about how corporations came to be and how they came to be so powerful. There is nothing wrong in my mind with powerful corporations. More important is how they exercise their power and what moral, ethical and legal power we have to place constraints on their exercise of power.
It put me in mind of something I read some time ago written by Art Kleiner - The Age of Heretics
Kleiner, summarizing John P Davis' book Corporations (Capricorn Books1961), traces the history of the modern corporation back to “the monasteries of the early Christian Church’. Commercialisation came when the mercantile stock companies began organizing expeditions to far parts of the globe across dangerous waters:
If a ship failed to return, the owner would qualify for debtor’s prison; if an owner died before a ship returned, his creditors might not be paid. Thus European kings and queens chartered corporations — creatures of legal sovereignty, named after the Latin word for “body.” The stock company had no human body, but it was corporeal in every other sense. It could own property, outlive its human members, and borrow or lend money. The monarchs had designed these new institutions to carry out the policies that they found too risky to undertake themselves.
Kleiner goes on to recount a major turning point in corporate history when, in 1811, the New York legislature
established a blanket corporate charter. Anyone who met the legal criteria was automatically granted the powers of a company.
This led to a flurry of legislation as the states of America at one and the same time competed to attract entrepreneurs but also limit those same entrepreneurs’ abuse of privileges the legislatures had granted them. Finally, Kleiner concludes:
By 1945, … the commercial corporation had come to dominate the culture of the world.
I have posted this brief history because over the next few days I want to discuss the purpose of corporations. Corporations were, and still are, created by an act of the state. Individuals are given protection and privileges under law to act as a company. In return the state can expect those same companies to meet certain obligations and responsibilities. There's plenty of room to discuss what those obligations and responsibilities might be, but that they exist and corporations have both a legal and moral duty to meet them is beyond dispute.
Posted by chriscurnow at 11:08 AM | Comments (0)