The latest financial crisis, as well as the 2001-2002 Enron and Worldcom accounting scandals, are both linked to the narrowly focused criteria prevalent in the United States for judging the success of corporate management and governance, said Shyam Sunder, a professor of accounting, economics and finance at Yale University School of Management.
Sunder blamed the traditional emphasis placed on shareholder value in U.S. corporate management, and suggested that the quality of management and governance of a company be judged on how much wealth it creates for all stakeholders, including customers, employees, community and shareholders.
And this broader perspective of management, which could contribute to avoiding future crises, has wide support in Japan, Sunder told the May 29 symposium.
Sunder said there is no perfect solution for good management. “Good management is a constant struggle to design and redesign an organization’s alliance in response to changes in its environment. There is no single solution that fits all or remains effective for long,” he told the audience.
A corporation, Sunder said, can be seen as an alliance or contract among various parties, such as managers, government, auditors, vendors, customers, employees, creditors and shareholders, with each party contributing to the organization in return for what they want. “Managers and employees contribute their skills in exchange for compensation and human capital. Government contributes public services in exchange for taxes, vendors contribute goods and services in exchange for cash, customers contribute cash in exchange for goods and services, and so on,” he said.
An organization is “managed well when all its participants find it in their own best interests to do what is expected of them” by the other participants, he said.
Sunder said the performance and management of such an organization should be measured by the sum of the net income that each of those parties earns from their participation. A traditional concept that focused on the flow of resources to shareholders alone is “neither true in practice nor desirable in the long run because exclusive pursuit of shareholder interest leads to poor management and poor results for even the shareholders in the long run,” he said.
He went on to say that the discipline for good management calls for laws, markets and social norms, and that a careful balance among them is necessary because total dependence on any of them — any one or two — is unlikely to provide a satisfactory outcome “because all three are susceptible to failure.”
Traditionally, in corporate governance in Japan, social norms, and trust of the corporate community, government and society played a very important role, Sunder noted.
“I think that’s a better system of governance. It does not mean it cannot be improved upon, but I think the world of corporate governance that was discredited after the Enron and Worldcom failures ignored the role of social trust and social norms, and focused almost entirely on shareholder value,” he said. “Shareholder value is important, but a corporation does not create wealth only for the shareholders” and in fact “most of the wealth created by corporations is not for the shareholders. It’s for customers and then for employees.”
Social norms have also tended to be ignored in corporate financial reporting in the U.S., Sunder said. “Since the introduction of federal securities laws 80 years ago, there’s been a progressive shift in corporate financial reporting from dependence on social norms of the business community and accounting community toward increasing — and now almost total — dependence on written accounting standards and discarding of social norms,” he said.
And during the last decade and a half, “there has been a great deal of pressure toward international accounting standards — pressure on countries and corporations to adopt a single set of standards under the label that a single set of so-called high-quality, uniform standards will lead to better corporate financial reporting, and comparability of financial statements across countries, economies and industries,” he said.
Sunder said the recent events and the financial crisis “made it clear that the promise of international financial standards was a false promise.” An increased dependence on written standards has not led to better financial reports but instead “created a huge financial engineering industry on Wall Street, where new derivatives are created precisely to get around the new accounting rules, so you don’t have to show liability and risk on the balance sheet,” he said.
The approach to creating a world monopoly of accounting standards and giving it to certain parties “has been demonstrated to be a bad approach, and I hope that Japan will retain its standards and not succumb to the pressure for (switching to) international accounting standards,” Sunder said.
Sunder said regulatory competition is a better model for accounting and corporate governance. “I hope Japan will retain its standards and allow Japanese corporations to choose to report by Japanese standards or international standards if they so wish. And let the markets, with the help of stock markets and the financial analysts community, decide which financial reporting is better,” he added.
Wouter Dessein, an economics professor at Columbia Business School, meanwhile, said the mainstream view in the U.S. still places importance on maximizing shareholder value.
“Maximizing shareholder value can have some excesses, but I believe it has a lot of benefits because it creates a very clear objective of what a firm should be doing,” Dessein said. However, if managers say that is all the matrix that they need to think about, they could get confused and will have an excuse for bad performance, he said.
Most studies of corporate management practices show that firms with dispersed share ownership and focus on shareholder value are well managed, Dessein told the audience. Companies like Enron that went under actually “destroyed value for their shareholders” and it’s not because of the emphasis on shareholder value that their problems emerged, he said.
He also said companies, in trying to maximize value for their shareholders, will need to increase value for other stakeholders as well. “As long as we have competitive labor markets, if you want to attract the best people you need to treat them well, so (in order to) maximize shareholder value, you need to treat your workers very well, you need to treat your suppliers very well, otherwise these people won’t want to work with you,” he said.
Citing data from a major survey by a British research institute of about 5,000 manufacturers worldwide, Dessein said good management practices — along with innovation and strategy — can be a source of competitive advantage.
According to the survey, better management practices can explain up to 30 percent of the differences in corporate performance between countries — and the difference between firms in a given country, the scholar told the audience.
While average Japanese and American firms were shown to have better management practices than average firms from emerging powers like China and India, the scores vary widely among companies within a given country — meaning that many corporations in advanced countries are doing worse than many Chinese or Indian firms, Dessein said.
The survey showed that although Japanese firms tended to excel in factory operations management, their score on personnel management was generally lower — which may be attributable to the relatively high rigidity of the job market in the country, he noted.