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Davis, Gerald
  Gerald Davis

Why Corporate Governance Doesn't Work Like it Should

8/2/2005 --

The late-1990s stock-market bubble and subsequent wave of corporate scandals show corporate governance does not work as advertised.

ANN ARBOR, Mich.—Corporate governance has become a hot button with the Securities and Exchange Commission, Congress, the federal courts and the news media.

Yet, current views regarding the original purpose, current function and collective impact of corporate-governance structures, processes and institutions fail to fully explain corporate behavior.

One thing is clear, however, says Jerry Davis, a business professor at the University of Michigan: Corporate governance works a whole lot better in theory than it does in practice.

"The stock-market bubble and related corporate scandals of the late 1990s and early 2000 provide evidence that corporate governance does not work as advertised, even in the United States," said Davis, professor of management and organizations at the Stephen M. Ross School of Business.

Corporate governance concerns the institutions that enable investments of financial, human and social capital in organizations, from boards of directors to legal frameworks and financial markets to broader cultural understandings about the place of the corporation in society. More broadly, corporate governance describes the institutional matrix that channels financial flows.

In his article "New Directions in Corporate Governance" in the August 2005 issue of the Annual Review of Sociology, Davis contends that because public corporations are among the most dominant actors transnationally, examining corporate governance is critical for understanding global structures of power.

"In a world of vast, unprecedented cross-border financial flows, governance is an essential component of the contemporary global economy," he said.

Sociologists have been critical of the "contractarian" approach to the corporation, which is based on the notion that corporations should be run to create shareholder value. This approach rapidly established itself as the dominant framework in the 1980s and had a substantial influence on public policy and managerial discourse.

Contractarians contend that financial markets are informationally efficient and, thus, that prevailing stock prices serve as economic guides. Corporate-governance institutions are explained by their function in orienting decision-makers toward signals in financial markets. The contractarian approach also holds that corporate structures, state corporate law and securities markets have evolved to serve the function of enhancing shareholder value.

"Sociological work, particularly within organizational theory, has questioned the empirical and theoretical underpinnings of this functionalist view and provided alternative interpretations based on networks, power and culture," Davis said.

Some studies, for example, have examined the impact of "interlocking" boards of directors, where individual directors serve on two or more boards at once. Other researchers have documented the influence of both behavioral and structural factors (e.g., the nature of relationships between CEOs and members of their board) and broader cultural factors (e.g., how changes in the prevailing rhetoric around corporate governance were filtered through discrete corporate practices).

In essence, sociologists say the divergence between the American theory of corporate governance and what happens on the ground is due largely to the "human economy," i.e., the people embedded in institutions, their social relationships with each other and their ability to manipulate the system to their own advantage.

"We can only hope that in five years there will be a fully developed sociology of corporate governance to provide a theoretical counter-weight to the deficiencies of the contractarian approach," Davis said.

For more information, contact:
Bernie DeGroat
Phone:(734) 936-1015 or 647-1847