Disrupting the agency model of corporate governance

Digital disruption poses many challenges for companies that rely on traditional business models and is forcing them to innovate to survive. Corporate governance regulators too are also having to innovate, one example being the recent changes to the rules to allow dual-class shares for the local market.

However, the overall approach to regulation still relies heavily on a decades-old agent-principal model where company managers are assumed to be agents of shareholders. This then begs the question - if some areas of traditional governance are being disrupted to meet the needs of the new economy and if companies themselves are changing their ownership structures, is there a need to rethink the agent-principal relationship?

For more than 40 years, corporate behaviour has been viewed through the lens of the "agency theory''. The main premise - shareholders own the corporation and are "principals" with original authority to manage the firm's business and affairs.

Managers are therefore seen to be agents of shareholders who carry out business in line with shareholders' interests, not least to maximise shareholder wealth. Hence, it is said that management owes a fiduciary duty to shareholders to boost the value of the firm, with the share price being the most common yardstick. This has given rise to many familiar governance practices today - for example, the granting of share options to managers so as to align their interests with those of shareholders.

It has also bred the current approach to corporate governance, centred on the need to monitor and control the actions of managers. The mechanisms thus advocated by governance codes and listing requirements include a largely independent board and chairman, independent board committees, high levels of corporate transparency and checks on executive pay.

Despite its widespread adoption, the agency model is not without its critics. One complaint is that if profits and share prices are key performance metrics, managers may overly focus on the short term and ignore longer-term planning. This is all the more relevant in today's disrupted world, given the importance of innovation and that innovative activities are inherently long-term and risky in nature. Two Harvard Business School professors have highlighted the theory's flaws: shareholders have no legal duty to protect or serve the companies whose shares they own and are shielded by the doctrine of limited liability from legal responsibility for those companies' debts and misdeeds.

"Moreover, they may generally buy and sell shares without restriction and are required to disclose their identities only in certain circumstances. In addition, they tend to be physically and psychologically distant from the activities of the companies they invest in,'' Joseph Bowers and Lynn Paine asserted in a Harvard Business Review article, The Error at the Heart of Corporate Leadership. The professors also voiced concern that the agency-based model of governance and management is being practised in ways that are weakening companies and that could be damaging to the broader economy. They proposed instead a more holistic, company-centric alternative model that would have at its core the enterprise's health, rather than returns to shareholders, and refocus companies' attention to innovation, strategic renewal, and investment in the future. Upending the agency model of corporate governance is a radical idea - and good food for thought.