The Enlightened Corporation | Episode 1: Resolving Existential Questions

In this pilot episode, I reflect on the need and the reasons for studying corporate governance, explore the connection between b-schools and corporate scandals, understand the pitfalls of economics-oriented management theories, and wonder if we could imagine an enlightened corporation.

The lecture hall was packed. With an uncomfortable smile, the professor confessed that for all the years he’s been teaching corporate governance, there wasn’t a class more than forty students. Though he prefers a smaller intimate setting for his corporate governance session, he said he was heartened by the response to the course.

Why Corporate Governance?

There is a need to set a backdrop for corporate governance. Enron is a useful example. The shareholders of Enron lost $74 billion in the four years leading up to its bankruptcy, its employees lost their jobs and billions in pension benefits, and some other companies are still reeling from the impact. Creative accounting, conflicts of interest, and an ineffective board were some of the causes of the Enron scandal. The question is if the Enron debacle could’ve been prevented. This, in fact, is the mandate of corporate governance.

To limit ourselves to a simple working definition, corporate governance is the mechanism that regulates the management to act in the best interests of the shareholders and other stakeholders while preventing it from acting in a self-interested manner. In recent times, the importance of corporate governance has been growing. In the aftermath of the deregulation of the 1980s and as a consequence of many corporate scandals, there has been a burgeoning focus on corporate governance.

Why corporate governance in b-school?

Personally, my inclination towards business ethics, public governance, and kinder capitalism naturally lead to my interest in corporate governance. But I only knew corporate governance had something to do with boards which held the management accountable, and that companies which had better corporate governance had more credibility. In earlier courses, we had dealt with brief aspects of corporate governance in cases on earnings manipulation, and investment analysis frameworks included the evaluation quality of management. I remember at least once when we closed a case declaring that poor corporate governance doomed the company. I wanted to be in this class to understand more about this.

But there is a need to ponder upon the functional reasons for studying corporate governance when one is just at the beginning of his managerial career. Why is it being taught at all? Research conducted by Aspen Institute has found evidence that b-schools have an influential impact on the future manager’s behavior. Discussing corporate governance could enable the students to adopt the right attitude and behavior towards the corporate governance system in their organization. I agree that I don’t have a complete answer now. But I believe the answer as to why corporate governance in b-school will be revealed gradually as the course progresses and we do the cases.

B-Schools Caught Red-handed

Our professor had aptly mandated a pre-reading that pretty much answers the above question. The article titled ‘B-Schools share the blame for Enron‘ by Sumantra Ghoshal written in July 2003, post the Enron scandal. The pre-read quite subtly set the raison d’être of corporate governance in a b-school classroom. Ghoshal, a late professor at London Business School, argues that the behavior of managers is due to certain theories being taught at b-schools and the academicians who invented them. He elucidates this with three prominent theories that occupy a primary place in management education.

Michael Jensen’s agency theory taught b-school students that due to the fundamental nature of man, managers cannot be trusted to do their job, which was to maximize shareholder value. To overcome this, employee stock options were proposed. With hindsight, it is easy to see the pitfalls of the employee stock options. It gives incentive for the management to indulge in excessive risk-taking to increase short term benefits and bonuses, inflate profits, and cook accounting books. Again Enron is a great example. Oliver Williamson’s transaction cost economics proposed that employees must be tightly controlled by managers so they do what they’re told. Porter’s five competitive forces, suggested that the company has to compete with its employees, suppliers, customers, and regulators in addition to its competitors to make profits. Thus profits come from distorting the market, which is what managers are paid for and must pursue though it may negative social impact.

It is not just the b-school students who imbibed the above theories, it is also the executives who’ve ever taken a business course, and simply anyone because these theories have attained great intellectual currency in our times. Thus, these theories have shaped the general behavior of the managers at firms like Enron.

The late professor says that the problem lay in b-school academics’ effort to pretend that business is a science. They tend to treat business as a kind of physics in which individual choices have no role to play. However, unlike physical sciences social theories including management theories are self-fulling:

A theory of sub-atomic particles does not change the behaviour of those particles. A management theory, if it gains enough currency, changes the behaviour of managers. Whether right or wrong to begin with, the theory becomes “true” as the world comes to conform with its doctrine.

Too much Emphasis on Economics

As we discussed these theories, our professor asked us if there was a common thread connecting the three leading academics mentioned by Ghoshal who’ve had a great influence in management studies.

One of my colleagues responded that they were all are from the US. The professor smiled at the obvious, the US was the Mecca of management studies and b-schools. But he did concede that the US socio-economic culture definitely does have an impact on the theories proposed. However, we were looking for something more.

The professor revealed that all three management thinkers had a background in economics. As a result, their management theories were grounded in economics while deemphasizing the other facets. Management, in reality, was a mix of economics, psychology, and sociology.

The professor posed a provocative question, “Does an MBA make you better managers?”

This is among the most uncomfortable questions one can face in a b-school classroom. There was a moment of awkward silence. The professor put an end to our misery by declaring that no doubt MBA’s return better performance. He quoted a study that found CEOs with MBAs to achieve 91% shareholder returns while their non-MBA counterparts achieve 81%. But this was economic performance. None of us know at what cost this performance was achieved?

Judging management performance on shareholder returns alone (financial economics) sounded familiar. It was the strategy simulation we had done in a previous term. The team performance was graded on shareholder returns. Thus, the teams made decisions on the location and shutting down of factories on a strictly economic basis. The loss of jobs and impact on society was not a consideration. We were being trained on a simulated environment where shareholder return trumped everything else. This stands a perfect testimony to Ghosh’s article.

Rescuing Mankind from Evil Corporations

The rise in corporate fraud and the general distrust of corporations and the impact such misgovernance can have on the global socio-economic system is well established. But could corporations pose a threat to the survival of mankind? Brian Moench’s article ‘Mankind: Death by Corporation‘ takes upon this subject:

Ironically, created by and managed by humans, corporations have become almost robotic monsters, perpetrating, even feeding off human misery, threatening every aspect of human life – the air we breathe, the water we drink and the food we eat – and even the future of mankind itself.

Brian argues that corporations pursue profits to the detriment of everything else – environment, people, and humanity itself. He cites examples from the tobacco industry, the lead industry in the second half of the twentieth century, Monsanto’s GMOs, the fossil fuel corporations, the nuclear industry, and the pharmaceutical industry.

Should corporations necessarily pose threat to mankind? I think corporate organizations do not necessarily have to be monsters to do well. We had a moment in history when it was acceptable for individuals to be draconian and kill fellow beings. Then, it changed. We have a better moral framework and codes. It could be the same with corporations. They might have been inhuman in the past but they don’t have to be so. There is hope for better corporations. Good corporate governance will lay the path to better corporations and b-schools are the right places to begin.

Coming up | Episode 2: The Building Blocks of Corporate Governance