BEHAVIORAL APPROACH TO CORPORATE GOVERNANCE? DEPARTMENT OF - - PowerPoint PPT Presentation

9 NOVEMBER 2018 FULL PROFESSOR MIRIAM FLICKINGER

AARHUS UNIVERSITY DEPARTMENT OF MANAGEMENT

WHAT CAN YOU LEARN FROM A BEHAVIORAL APPROACH TO CORPORATE GOVERNANCE?

MIRIAM FLICKINGER 29 NOVEMBER 2018 FULL PROFESSOR

AARHUS UNIVERSITY DEPARTMENT OF MANAGEMENT

AGENCY IN CORPORATE GOVERNANCE

CORPORATE GOVERNANCE

Shareholders

Stakeholders MONITORING PERFORMANCE Code

E thics

Strategy

DIRECTORS

TOP MANAGERS

LAWS Policies Transparency PROCEDURES CONTROL System PRACTICES

MIRIAM FLICKINGER 29 NOVEMBER 2018 FULL PROFESSOR

AARHUS UNIVERSITY DEPARTMENT OF MANAGEMENT

AGENCY IN CORPORATE GOVERNANCE

CORPORATE GOVERNANCE

Shareholders

Stakeholders MONITORING PERFORMANCE Code

E thics

Strategy

DIRECTORS

TOP MANAGERS

LAWS Policies Transparency PROCEDURES CONTROL System PRACTICES

OECD/European Central Bank Definition

Corporate Governance

• procedures and processes according to which an organization is directed

and controlled

• specifies the distribution of rights and responsibilities among the different

participants in the organization – such as the board, managers, shareholders and other stakeholders

• lays down the rules and procedures for decision-making.

Fama & Jensen (1983), Jensen & Meckling (1976)

Agency in Corporate Governance

• Economic/legal theories of governance rely on assumption of homo

economicus

• Humans as self-interested agents who pursue their own utility in a

rational way

• 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

MIRIAM FLICKINGER 29 NOVEMBER 2018 FULL PROFESSOR

AARHUS UNIVERSITY DEPARTMENT OF MANAGEMENT

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

MIRIAM FLICKINGER 29 NOVEMBER 2018 FULL PROFESSOR

AARHUS UNIVERSITY DEPARTMENT OF MANAGEMENT

BEHAVIORAL GOVERNANCE: SOCIALLY SITUATED AND SOCIALLY CONSTITUTED AGENCY

Self-interested, agency-

• rientiented

behavior of individuals „Socially situated“ agency „Socially constituted“ agency Social relationships networks institutions Individual backgrounds experiences

Westphal & Zajac (2013), Little (2012), Koo (2011)

Socially situated agency

Influence of the social environment on utility-maximizing behavior, e.g.:

• Social influencing of others, e.g. interpersonal influence

behavior or symbolic management

• Social learning through mimetic decision processes
• Norms of reciprocity, especially among the corporate elite

Socially constituted agency

Influence of prior socialization and other personal experiences

• r characteristics, e.g.:
• Influence of social comparisons with other individuals

and/or groups (in-group bias)

• Group-dynamic processes, e.g. pluralistic ignorance or

group polarization

• Social identification
• Institutional logics and impression management

MIRIAM FLICKINGER 29 NOVEMBER 2018 FULL PROFESSOR

AARHUS UNIVERSITY DEPARTMENT OF MANAGEMENT

EXAMPLES AND RECOMMENDATIONS (1/2)

CEO dismissal Poor performance

Social Status social ranking and esteem accorded to an executive or board member in comparison to other members of the corporate elite Poorly performing CEOs can hold themselves in office more easily:

• When they have more status than the chairman of

the board

• When there are fewer network outsiders on the

board

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

MIRIAM FLICKINGER 29 NOVEMBER 2018 FULL PROFESSOR

AARHUS UNIVERSITY DEPARTMENT OF MANAGEMENT

EXAMPLES (2/2)

Corporate reputation

Excess total CEO compensation Excess amounts of contentious elements

• f CEO compensation

Overpayment

(+) (-)

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
• f (media) attention. This should be taken into account when designing CEO pay packages

MIRIAM FLICKINGER 29 NOVEMBER 2018 FULL PROFESSOR

AARHUS UNIVERSITY DEPARTMENT OF MANAGEMENT

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

MIRIAM FLICKINGER 29 NOVEMBER 2018 FULL PROFESSOR

AARHUS UNIVERSITY DEPARTMENT OF MANAGEMENT

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 situation? Ask for more analogies and compare them to the current situation Confirmation bias Are credible alternatives included with the recommendation? Request additional options Availability bias What kind of information would you want to optimally have? Use checklists of the data needed for each kind of decision 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 decisions? Consider the issue as if you were a new CEO 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)

MIRIAM FLICKINGER 29 NOVEMBER 2018 FULL PROFESSOR

AARHUS UNIVERSITY DEPARTMENT OF MANAGEMENT

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.

AARHUS UNIVERSITY DEPARTMENT OF MANAGEMENT