Corporate governance refers to “those administrative monitoring and incentive mechanisms that are intended to reduce conflicts among organizational actors due to differences in incentives” (Lubatkin et al., 2007, p. 43). In other words, governance concerns the structure of rights and responsibilities among the parties with a stake (i.e., stakeholders) in a firm (Aguilera & Jackson, 2003; Aoki, 2000; Usunier et al., 2011). Corporate governance organizes the relationships among stakeholders, which in turn determine and control the corporate level strategies and performance of firms. Modern corporations, characterized as they are by the separation of ownership and managerial

control, use managers as decision-making specialists who act on behalf of the firm’s owners (Berle & Means, 1932; Chandler, 1977; Demsetz, 1983; Fama & Jensen, 1983). As such, they have some latitude (i.e., discretionary power) to make strategic choices that should be in the best interest of the firm’s owners (Jensen & Meckling, 1976). They also are primarily responsible for the performance and sustainability of the firm (Barnard, 1938; Fligstein & Shin, 2007). However, self-interested managers may make corporate level strategic decisions that maximize their own personal power and welfare and minimize their personal risk rather than maximizing shareholder value (e.g., Amihud & Lev, 1981; Berger et al., 1997; Jensen & Meckling, 1976; Jensen & Murphy, 1990). In this chapter, we argue that in addition to shareholders, top managers are responsible to other stakeholders and, to some extent, to society at large (Carroll, 1999; Freeman, 1984). In this sense, corporate governance requires controlling the risk of opportunism by top managers as well as ensuring that the firm meets its corporate social responsibilities. Agency theory pertains to the conflict of interest between shareholders and top managers

(Berle & Means, 1932); it provides the dominant theoretical perspective on corporate governance systems. The potential areas of conflict between shareholders and managers include the election of directors, the supervision of CEO pay, and the firm’s overall structure and corporate level strategies (Fama & Jensen, 1983). As we have discussed in several chapters of this book, diversification is one such corporate level strategic decision that may reflect an influence of managerial opportunism (Denis et al., 1997, 1999). For example, corporate diversification might enhance a firm’s value, which would serve the interests of both shareholders and top managers. But it also might result in benefits only to top managers that shareholders do not share, in which case managers prefer more diversification than do shareholders (Hoskisson & Hitt, 1990; Montgomery, 1994) (see Chapter 2). Specifically, diversification likely increases the size of the firm, and size often relates positively to top managers’ compensation (Cordeiro & Veliyath, 2003; Gray & Cannella, 1997; Wright et al., 2002). Moreover, diversification increases the complexity associated with managing the firm and its portfolio, such that managers might demand increased pay to deal with this complexity (e.g., Geletkanycz et al., 2003). Because increased diversification gives top managers a

means to increase their compensation, they may be motivated to engage in ever more diversification (Finkelstein & Hambrick, 1989; Wright et al., 2002). Several studies provide empirical support for this managerial compensation motive (Brenner

& Schwalbach, 2003; Denis et al., 1997, 1999). As mentioned in Chapter 2, shareholders tend to prefer riskier strategies and more focused diversification, because they can reduce their risks in other ways, such as holding a diversified portfolio of equity investments. In contrast, managers cannot diversify their employment risk by working for a diverse portfolio of firms (Fama, 1980), which should cause them to prefer a higher level of diversification that increases their compensation and reduces their employment risk. According to agency theory then, shareholders must control the work of top managers to avoid self-serving opportunistic behaviors, which would be detrimental to their interests (Denis et al., 1997, 1999). However, this argument relies on a key, but also controversial, assumption of agency theory-

that is, managerial opportunism (Ghoshal, 2006; Ghoshal & Moran, 1996). In management literature, as well as economic and strategic literature, several assumptions persist about the goals managers pursue. For example, neoclassical economists (e.g., Jensen & Meckling, 1976; Williamson, 1975, 1985) assume that managers are opportunistic and only motivated by self-interest, but this assumption has been subject to frequent challenges. Davis et al. (1997) hold that most managers actually are highly responsible stewards of the assets they control and do not behave opportunistically. With this alternative view of managers’ motives, they propose stewardship theory, according to which shareholders should install more flexible corporate governance systems to avoid frustrating their benevolent managers with unnecessary bureaucratic controls. By focusing on the relationship between shareholders and managers, agency theory also takes

a narrow view of corporate governance and the responsibilities of top managers. Stakeholder theory broadens this view by arguing that managers are responsible not only to shareholders but to the larger group of stakeholders (e.g., Freeman, 1984; Mitchell et al., 1997). However, when multiple stakeholders’ interests represent ends to be pursued, managers must make strategic decisions that balance these multiple goals rather than just maximize shareholder value. Stakeholder theory in turn proposes that managers’ goals should be developed in collaboration with a diverse group of internal and external stakeholders, even if they support potentially conflicting claims (Freeman, 1984; Mitchell et al., 1997). Furthermore, with regard to corporate governance, the stakeholder perspective asserts that managers should be controlled not just by shareholders but by other stakeholders as well. Again, according to agency theory, managers are solely responsible to shareholders, so their

actions must aim to maximize shareholder value: They should be accountable only for making a profit (Fligstein & Shin, 2007; Friedman, 1970). In this scenario, as Daily et al. (2003) outline it, corporate governance identifies ways to ensure effective strategic decisions, regardless of potential agency problems. However, if the number of stakeholders to whom managers are accountable increases, the scope of a firm’s corporate responsibilities also increases. Carroll (1979, 1991) therefore argues that not one but four types of corporate social responsibilities exist: economic, legal, ethical, and discretionary (or philanthropic). These four responsibilities also can be classified into two broad types: social (discretionary,

ethical, and legal) and economic (Aupperle et al., 1985; Furrer et al., 2010). Carroll (1979) identified the environment as a social issue for businesses, but stakeholder theory (Freeman 1984; Mitchell et al., 1997) instead calls the environment a third dimension that pertains to firms’ responsibilities to maintain ecologically sustainable relationships with biophysical and societal environments (Shrivastava, 1996). Managers’ strategic choices therefore must reflect a compromise between various considerations-of which shareholder value is just one (McWilliams & Siegel, 2001). Corporate governance also is a vast subject that could be (and has been) the object of a book

on its own. In this chapter, we therefore limit ourselves to only those issues that pertain to corporate level strategies. Specifically, this chapter focuses on corporate governance as a mechanism

designed to control managerial opportunism (Furrer, 2013). We start by presenting corporate governance based on an agency theory perspective and draw implications from its main assumptions. Then we start relaxing some of those assumptions. First, we mitigate the idea that every manager is opportunistic and present stewardship theory. Second, we relax the assumption that the ultimate goal of a corporate level strategy and managers’ sole responsibility is the maximization of shareholder value and therefore offer stakeholder theory as an alternative. Finally, we discuss how to expand a firm’s corporate responsibilities from making a profit to encompass broader economic, social, and environmental responsibilities.