In the corporate law community, we too often claim that good corporate governance is a competitive advantage. But what is the social-science evidence for that claim?
We warn clients about Caremark and other sources of liability for poor corporate governance. (See, e.g., Bird and Manning Magrid’s excellent piece in the pages of this blog.) And we suggest that better-run organizations not only avoid liability, but are more successful than their competitors. Do we know this to be true? Through what mechanisms might good corporate governance provide a competitive advantage to an organization?
In a recent chapter, we look for more scientific answers to these questions, as well as clues for what to investigate.
What’s “Corporate Governance”?
In the law and management science literature, corporate governance is broadly defined as how an organization runs itself and the processes by which it decides what it wants to do. The term refers primarily to internal processes and controls of an organization, although those processes and controls can affect the behavior of an organization in the marketplace and in relation to the rest of the world.
Many processes are rooted in fundamental concerns such as accounting, transparency, fairness, and responsibility. Typical governance issues include “(1) how an organization is managed to optimize performance and accountability, (2) how values and goals are reflected by the systems and structures that are created, (3) how leaders establish relationships that engender the commitment of those who work with and for them, and (4) how the application of leadership is formally applied in the conduct of organizational business” (Caldwell & Hansen, 2010: 178-79; see also McClusky, 2002; Steinberg & Pojunis, 2000).
What Is “Good” Corporate Governance?
Adequate corporate governance “spells out the rules and procedures for decision-making, accountability and transparency, and distributional rights.” (Anheier & Abels, 2020: 1.) Among other topics, it must address “the distribution of rights and responsibilities among stakeholders, including owners, shareholders, debtholders, boards, managers, employees, customers, and regulators.” (Ibid.) “Good” corporate governance seems to create more harmonious decisions.
What Is “Competitive Advantage”?
Competitive advantage is how a firm performs in a way that is superior to its competitors. There are both internal and external sources of competitive advantage. (Porter, 1998.) Sustained competitive advantage can maintain a firm’s profitability above its competitors’ and the industry norm. (McGahan & Porter, 1999.) Strong and repeatable competitive advantages can help businesses attract capital, including human capital in the form of talent and expertise, more cheaply and easily. (Kryscynski, et al., 2021.)
Is There a Logical Problem With Equating Competitive Advantage and Good Corporate Governance?
An interesting question is whether corporate governance remains a competitive advantage when rival companies also engage in it, possibly because they are required to do so by legal reforms. (Cf. Adam & Zutshi, 2004.) As Professor Constance Bagley describes, “[a] capability confers competitive advantage under the resource-based view of the firm only if it is valuable, inimitable, nonsubstitutable, and rare.” (Bagley, 2008: 378; citing Barney, 1991, and Peteraf, 1993 (emphasis added).)
There are two main responses to this concern.
First, good corporate governance still seems rare. As professors Robert and Dowling show in the context of corporate reputation, part of why companies can sustain performances that are better than their competitors’ is because good corporate governance, and especially rooting the desire to maintain good corporate governance in a company’s culture over the long term, appears to be intangible and difficult to replicate. (Roberts & Dowling, 2002.)
Second, even among companies that engage in good corporate governance, there remains significant room to do better.
What Are the Mechanisms for Corporate Governance’s Impact on Competitive Advantage?
The chapter surveys the literature on internal vs. external impacts of corporate governance, but to see why corporate governance can lead to competitive advantage, we need to better understand the mechanisms that link the two .
Most mechanisms focus on a particular quality of competitive advantage, and others focus on an outcome that is often tied to the exercise of good corporate governance. The three mechanisms of (i) trust, (ii) commitment, and (iii) empowerment of key personnel are arguably most directly tied to the quality of a firm’s corporate governance. The next three mechanisms of (iv) better communication with stakeholders, (v) better planning for the future, and (vi) synthesis of procedures and values more overtly include sustainability and social justice choices.
There has also been work attempting to establish a corporate-governance connection, as suggested by the United Nations in its push for ESG, to competitive advantage through an organization’s choices on social justice and sustainability. The evidence is still developing, but a body of literature has posited that corporate governance helps companies better plan for their futures, which, in turn, leads to better decision-making and greater long-term profits. (See, e.g., Ameer & Othman, 2012.)
Additionally, some authors suggest that a synthesis of good corporate governance procedures with pro-social and environmental values creates competitive advantage because companies that sustain such synthesis may be easier to run internally and externally. (See, e.g., Rowe, 2001.)
Words of Caution
In reviewing the law and management literature, we must recognize the circularity of many of its definitions, such as that good corporate governance includes running a company for the benefit of its many stakeholders (see definitions; but see Bainbridge, 2023). It has certainly been the work of many people and organizations connected with the United Nations to pull E, S, and G together in our thinking on these issues. (Pollman, 2022; see also Larcker, et al., 2021.)
It would be an interesting next development to better isolate corporate governance, as the UN also sees it, as a set of anti-corruption procedures. That more narrow evaluation might allow us to focus on the effectiveness of individual corporate governance techniques.
We still do not engage in corporate governance effectively (see, e.g., rarity and implementation issues), and we could learn more about what specific reforms to processes would mean for the direction of organizations. Professor Aguilera and her co-authors, for example, argue that we should be thinking about corporate governance procedures more expansively to include outside monitors. (Aguilera, et al., 2015; cf. also Coffee, 2006.)
Finally, we have the intriguing suggestion from organization theory that, the more competitive stress a company is under, the more it might benefit from formal, as opposed to organic, governance procedures. (See, e.g., Sine, et al., 2006.) We should learn more about why certain procedures work under some conditions, and perhaps not under others.
Given the turbulent economic times, corporations might benefit from increasing their resistance to stress. Understanding more precisely how certain formal procedures help organizations respond more advantageously to market pressures seems like a promising way forward.
This post comes to us from J.S. Nelson, currently visiting at Harvard Law School’s Program on Negotiation. It is based on her recent chapter, “Corporate Governance as a Source of Competitive Advantage,” forthcoming in the book LAW & MANAGEMENT and available here.