Corporate governance and innovationlike problems: Comparing innovation
governance and agency theory
Peter Cebon
University of Melbourne
Parkville Victoria Australia
[email protected]
Introduction
• Boards of directors have three roles:
1.
2.
3.
•
•
The corporate governance literature assumes boards split these
roles between them
However
–
–
–
•
Oversee strategy creation
Monitor the executives
“Help out”
Roles 1 and 2 (as theorised) imply incompatible practices
The two roles are only separable in firms that don’t innovate
Boards need to act as a coherent team
This creates a problem
–
–
Agency theory requires the roles to be split
Shareholder activists assume the roles can be split
So what?
We shall continue to characterize the agency conflict between the
owner/manager and outside shareholders as deriving from the
manager's tendency to appropriate perquisites out of the firm's
resources for his own consumption. However, we do not mean to leave
the impression that this is the only or even the most important source
of conflict. Indeed, it is likely that the most important conflict arises
from the fact that as the manager's ownership claim falls, his incentive
to devote significant effort to creative activities such as searching out
new profitable ventures falls. He may in fact avoid such ventures
simply because it requires too much trouble or effort on his part to
manage or to learn about new technologies. Avoidance of these
personal costs and the anxieties that go with them also represent a
source of on the job utility to him and it can result in the value of the
firm being substantially lower than it otherwise could be. (Jensen &
Meckling, 1976:313)
Summary of approach
• Are upside and risk equivalent?
• Partition corporate activities into
1. Routine operations
2. Innovation (incl. M&A, Change, IT change, etc.)
•
Consider normative governance for
–
–
•
Show incompatibilities
–
–
•
Innovation activities
Agency theory
Board coherence
Board competence
Lightning fast case study of CSIRO
Risk vs. upside?
Current
performance
Upside
Projected
performance
Risk
t=0
t=1
Current
performance
Upside
Projected
performance
Risk
t=0
t=1
Managing Innovation
• Innovation radicalness = f(analysability)
• Analysability varies with:
– Complexity
– Emergence
• Manage complexity
– By modularising and combining into an architecture, or
– By treating it as if it is emergent (e.g. Telstra billing system)
• Manage emergence
– Sensemaking activities (cocktail parties)
– Trial and error learning
• Emergence and complexity are highly risky, and can easily
blow out costs.
Governing innovation
• Tension between emergence and control
• Manage the tension by separation
– Simple projects (and project elements) – temporal
separation (e.g. agile software development)
– Complex projects – temporal and org’l separation
• Advantages of organisational separation
– Can inject expertise and diversity of thought
– Psychological safety (allocate responsibility upwards)
– Allows portfolio management
• Each project/solution approach is a real option
• Deliberately initiate excess projects/solution approaches, and then
kill them/let them die/redirect them (e.g. stage-gate, waterfall)
• Manage the portfolio to enact the strategy
Gate 1
Product/process idea generation and
concept development (including
advanced development, identification
and review)
Gate 2
Detailing of proposed project
bounds and required
knowledge
Wheelwright and Clark (1992) – Exhibit 5-6
Rapid, focused
development projects of
multiple types
Innov. and corporate governance
• Innov. governance requires:
– Knowledgeable governors
– The governors and the governed must trust each other
• Activities vary with corporate size, innovativeness
• The board cannot simply delegate it all
– Risk management is legally a board responsibility
– Cannot maintain psychological safety
– Governance is reduced to “feeling comfortable with the CEO”
•
•
•
•
CEO tenure < gestation for innovation
CEO incentive to milk old products with incremental innovation
CEO can easily tell glowing stories
Emergence may imply a change in strategy (e.g. Xerox)
– And signing off on major transactions
• Board starts to see the corporation as a nexus of contracts (hypothesis)
Governance and agency theory
• The corporate governance literature is very diverse
(across disciplines and legal systems)
• Codes of practice all assume agency theory, and all
ignore risk associated with strategy.
• Moral hazard arises because of misaligned incentives
• The board has two tools
– Incentives
– Monitoring
• A board that monitors will undermine trust.
• A truly independent board will generally not
understand the business.
Conflicts between the approaches
• Independent directors will rarely understand
the business
• CEOs cannot do sensemaking with
independent directors
• Low trust means CEOs will undermine
portfolio management (by bringing minimal
options as late as possible).
• Can’t resolve the conflict by hiring consultants
CSIRO Case
• Founded in 1926 – response to WWI – to create a research capability
• Expanded after WWII and float of dollar
• Left out of “Backing Australia’s ability” (2001)
– Threat of break-up
– Flagships program created in response
• Board supported flagships despite risks
–
–
–
–
Divisions would need to learn to work together
Organisation would need to learn to kill projects / programs
Not clear management could deliver
Board much more visible to Cabinet
• Changes in the board
– Extensive focus on the research pipeline
– Spends time designing the research portfolio (focus areas, applied vs. basic)
– Extensive focus on executive performance (competence, not malfeasance)
• Changes to CSIRO
– Budget increase
– Need to open up innovation process
Towards a research agenda
•
•
•
Rework/rethink agency theory
Case studies (CSIRO, CSC, Telstra?) + Surveys
How do boards understand their risk management roles?
– What practices do they place where?
– Grading the category “risk”
•
•
•
•
•
•
•
•
How do boards manage the conflict between agency and innovation issues? (or is
that the issue at all?)
Did corporations that had a more innovation-oriented approach to governance
manage the GFC better?
Do corporations that have effective innovation governance extend that to other
innovation-like problems?
How do board roles change as size changes?
Is there a set of “best practices” that can be taught?
Social innovation – how does it differ?
Consultants – do they have the skills?
Government cabinets as a metaphor?
Figure 3. Results of path analysis
General
Pressure
Market
Pressure
Theorizing
Agents
Learning
partners
Tech.
Exposure
Value chain
partners
*** p<0.001, ** p<0.01, * p<0.05 (one-tailed)
Control variables not shown (see text for list)
0.002 (ns)
0.006 ***
Normative
proximity
Conclusion
• Fundamental incompatibility between
innovation governance and agency theory.
• Cannot just ignore one or the other
– Ignoring innovation governance kills innovation
– Ignoring agency risk invites moral hazard
• Raises interesting empirical questions
• Suggests a need to rethink parts of agency
theory