Center for
Issue #41
December 2022
Professor Gaizka Ormazabal
Evaluating Corporate Governance Effectiveness in a Rapidly Evolving Context 
The corporate governance landscape has changed significantly in recent decades and continues to transform. Time-series data on key governance mechanisms in US listed companies clearly illustrates the evolution. The average percentage of independent directors is now close to 80%, up from just over 50% before the Sarbanes-Oxley Act (2002). This upward trend is accompanied by a dramatic decrease in the number of listed firms and in the frequency of hostile takeovers. We have also witnessed a spectacular increase in passive investment and the emergence of large asset managers with the potential to influence corporate decision-making (they own a significant percentage of firms’ shares).
And, of course, we should not ignore the exponential increase in the volume of ESG (environmental, social, and governance) investment, which already amounts to trillions of dollars in assets under management. Surprisingly or not, the surge in investment labeled “sustainable” has taken place alongside a rise in shareholder activism demanding firms to improve their ESG performance in several ways. Such activism is commonly articulated through shareholder proposals at annual meetings, but we also observe more direct engagement in conference calls, private meetings and even proxy contests. 
While many other factors could be at play, these trends probably reflect an evolution in the relative dominance of different corporate governance paradigms. Since the 1980s, there has been a growing emphasis on shareholder rights. This stemmed from a perception that the previous governance system gave too much power to managers, a concern that was fueled by the accounting scandals of the early 2000s and the 2007-2008 financial crisis. Currently, we hear many voices calling for what has been called “stakeholder capitalism”, which asserts that the purpose of corporations should go beyond maximization of shareholder wealth. The hope is that this alternative approach will help meet our societal challenges, including decarbonization, social inequality, health emergencies and geopolitical risks.
The ongoing debate on corporate governance is mainly focused on what we could call “externally observable mechanisms”, most notably the structural attributes of the board and its composition, anti-takeover defenses and other provisions defining shareholder rights, and top executive compensation contracts. Such a focus presents at least two problems. The first is that evidence on the economic consequences of these mechanisms is not always conclusive. For example, academic research shows that the effect of board independence on firm performance is nuanced and context-specific. The second problem is that, unfortunately, there is mounting evidence that these mechanisms by themselves are not enough to preempt misbehavior. 
But perhaps even more importantly, the limitations of these “externally observable mechanisms” become more apparent when taking the view that corporate governance is not only about monitoring managerial behavior but also about long-term value creation. In this regard, several observers have recently emphasized that the board should be involved in developing and implementing corporate strategy. 
All these developments suggest that researchers should probably devote more attention to the inner workings of organizations, particularly topics related to the interplay between culture, board dynamics and firm performance. But there’s one problem: researchers have very little publicly available data on these alternative dimensions of corporate governance.
One way to overcome this difficulty is to resort to surveys. A prime example is the study  presented by Paul Healy (Harvard Business School) in the recent 2022 IESE ECGI Corporate Governance Conference(1), which was centered on corporate culture and its impact on governance. Based on a sample of more than 500 directors, Healy and his co-authors drew two important conclusions. First, internal board operations (quality of information, board organization, meeting agenda, etc.) appear to be related to board effectiveness. The second finding is a statistical association between board effectiveness and key firm outcomes, including financial performance, reporting quality, compensation practices and M&A activity. According to the authors, the study “provides a first step toward quantifying and analyzing (board) attributes on a broad scale.” The results highlight the importance of the cultural and organizational aspects of board leadership. 
Studies like Healy’s are of high practical value, as they highlight relevant determinants of effective governance and provide recommendations based on rigorous research, not just opinions. Thus, this research opens an avenue of fruitful collaboration between firms and business schools and leads to a more holistic view of corporate governance, one that should be considered by boards, investors and regulators.

(1) The papers and presentations of the 2022 IESE ECGI Corporate Governance Conference can be found here

You can now watch all the sessions of the IESE-ECGI Conference 2022 on "Corporate Governance, Corporate Culture and the Board's Culture" that took place at IESE, Barcelona Campus, on October 3, 2022, here.
Upcoming programs

Corporate Governance Trends and News
Managing the CEO succession process can be challenging and many boards aren’t fully prepared for CEO departures, even though succession planning is one of their primary responsibilities. A recent example is Disney, which announced the immediate replacement of its CEO (Mr. Chapek) with his predecessor in the role (Mr. Iger), who had completed a tenure of 15 years and guided the transition of his successor. Board directors should take critical steps to be prepared for both planned and unexpected departures.
Although ESG investing is on the rise, a recent survey has found that individual investors have significant differences in their concern for ESG matters; their view of whether fund managers should use their voting power to influence ESG practices; and their willingness to decrease the return of their investment to pursue ESG objectives depending on their age and wealth. According to this survey, older individual investors are largely opposed to ESG and unwilling to diminish the value of their assets to advance in these objectives. In contrast, younger individual investors are more concerned about ESG issues and more willing to reduce the value of their investments to support these objectives. 
The results raise questions about how fund managers should determine their vote when their investor base may have such divergent views.
The survey polled 2,470 investors with savings ranging from less than $10,000 to more than $500,000 and was conducted by Stanford Graduate School of Business, the Hoover Institution Working Group on Corporate Governance at Stanford University, and Rock Center for Corporate Governance at Stanford University.
Linking executive compensation to ESG goals and performance continues to be an increasing trend and a highly debated topic as discussed in our July newsletter. A new study led by The Conference Board sheds light on the reasons why companies are embracing this trend, as well as the potential risks and challenges ahead. 
The European Parliament has approved the Corporate Sustainability Reporting Directive (CSRD), which sets out the new reporting rules for certain type of companies with regards to their environmental and societal impact and will replace the EU Non financial Reporting Directive. The Parliament expects that this new legal framework will “end greenwashing, strengthen the EU’s social market economy and lay the groundwork for sustainability reporting standards at global level”.
The CSRD introduces more detailed reporting requirements to ensure companies are providing reliable information that will be subject to independent auditing and certification.
IESE's Recent Research
CANALS, J. (2023). Boards of Directors in Disruptive Times. Cambridge: Cambridge University Press.
DURO, M., LÓPEZ-ESPINOSA, G., MAYORDOMO, S., ORMAZABAL, G., RODRÍGUEZ-MORENO, M. (2022). Enforcing Mandatory Reporting on Private Firms. The Role of Bankers. Banco de España Working Paper n. 2238.
BONETTI, P., ORMAZABAL, G. (2022). Boosting foreign investment. The Role of certification of corporate governance. Journal of Accounting Research.