Rethinking the Purpose of the Corporation

Abstract

For about forty years, corporate governance and corporate law focused on minimizing “agency costs” by aligning the interests of shareholders and managers through a series of techniques, including regulatory standards, independent directors, take‐overs and activist shareholders.These means, combined with implicit acceptance of the “Efficient Market Hypothesis” (EMH) reinforced belief that share prices reflected objective corporate performance and that maximizing shareholder wealth was the purpose of the corporation.This author, however, argues that proper corporate governance requires more than just faith in efficient equity markets and strong managerial incentives. Despite the desire for simplicity, there is no one “right” governance model. Governance is highly contextual and, ironically, the existing corporate law and regulation have tended to frustrate dynamic adaption and have led to governance systems that underperform.The author offers Systems Theory as a better way to think about corporate purpose and governance. Systems are more than the sum of their parts, they are comprised of subsystems which in turn are comprised of other subsystems on so on, and the overall health of the system depends on the continued health of each of its essential subsystems, as well as of the larger system.Systems theory counsels against focusing on any single metric (and in favor of the need for new ones — the relevance of metrics inevitably run down over time). Metrics such as profits, employee turnover, and customer satisfaction are not ends in themselves. Rather, they are a source of information about whether the corporation is relevant, resilient and sustainable. The systems challenge is to bring about a paradigm shift that restores connectivity between investors, employees, management, other corporate stakeholders and governments. This will require thinking differently about how the constituent elements interact and produce results.