Corporate Governance 2030: Thoughts on the Future of Corporate Governance

Context

Many commentators and pundits have been making predictions about a radically different corporate landscape than the one we are facing today. These predictions have been around for a while: the information and communications revolution was supposed to usher an era of smaller, more nimble companies with very few employees scattered around the world, facing millions of very well-informed rational consumers who buy on the web and can manage endless choice. These nimble supply players can change game plans at the speed of light. Their strategic decisions are not the result of hierarchy-bound iterations as in classic corporations. Rather, they emerge through some sort of networking osmosis.

This has not happened yet, and it might take a long while before it is really upon us, longer than 12 years. It might be true that companies in the ITC sector employ fewer people than old world companies, while enjoying vastly higher valuations and therefore market capitalisations. It might also be true that the information revolution has brought about a significant change in the pecking order of sectors. And AI is already changing significantly the tasks of human workers—and replacing many of them.

But wholesale corporate decentralisation has not happened: industrial concentration levels, if anything, have increased, largely as the result of powerful network effects, facilitated by an efficient merger “food chain”; which, in its turn, is efficiently intermediated by the capital markets. There are still small, medium and large businesses, and there is no indication that they will use boards less or in significantly different ways than their predecessors. The only thing that has probably changed is the funding of it all—the “food chain” works differently: it is now less about public equity markets and more about private flows of capital.

Where there were once IPOs now there are efficient private markets. The UK has now only about half the listed companies it had twelve years ago.

Much of the what this blog discusses is about emerging markets (EMs) and the often smaller, private companies that populate them. For them, the development of private markets is actually a very good thing. Most of these enterprises will benefit from the fact that capital markets are more comfortable and can more efficiently fund privately-owned businesses. The new “food chain” might present an opportunity to smaller, private businesses wherever they may be. For EMs this might translate into a chance to leapfrog developed economies.

Like everywhere else, technology might create significant, and disruptive opportunities in EMs, especially in sectors such as banking and payment systems. But EMs’ key competitive advantages will still be driven by traditional sectors where labour cost advantages are more important than opportunities for labour substitution. But even in those sectors where technology will play an increasingly significant role, the key issue of trust in a company and its institutional framework will not disappear. So, do not expect a change in the role of corporate governance as a generator of trust.

There is an important caveat. My thoughts are based on, some will say, bold assumption that the long-standing trend of global economic and regulatory convergence will continue. This convergence started a few decades ago and was framed by an international cooperation framework established after the second world war. As we all know these arrangements are now facing significant headwinds, probably stronger than at any other time in the last 80 years. My assumption is that what we are currently witnessing in geopolitical and international economic relations is a backlash, not a total collapse of that framework. If it is the later, then many of the points raised in this blog post might become irrelevant.

So, there will be changes in governance over the next twelve years in EMs and elsewhere; and sometimes they will be significant, albeit not earthshattering. Their drivers can be summed up under four broad headings: diversity, disclosure, data and DFIs.

Diversity

Diversity of all kinds and at all levels, is one of the most pervasive trends of the new millennium—a child of globalisation and convergence, but also of deep structural change in Western societies.

In the governance sphere, we speak about diversity mostly in the gender context. This is a very important subject and we are probably just at the beginning of a new social paradigm. What is happening in the West is setting the tone elsewhere—almost everywhere. This trend will increasingly impact private businesses across EMs, even in the most conservative places. Increasingly more young women in the elites will be educated just like their brothers. This will probably accelerate changes throughout society.

But diversity is much more than gender. And I will use it in this very broad sense of maximising the number of different perspectives around a decision-making table—the board.

In fact, boards were invented for diversity purposes: we want different voices around the table, not one king (or, rarely, a queen) who takes all decisions unchallenged. The wise drafters of 19^th century company laws did not have mental categories for “group think” and formulation or availability biases; but they could see that managing other people’s money (as Adam Smith put it) required more than a king-like powerful individual, no matter how honest or intelligent.

Of course, a basic common understanding of the business at hand is required around the table, and the more complex the business, the more this understanding comes at a premium. But the more diverse the people around the table are, the more likely the board is to avoid the trap of such biases when delivering productive, challenging, rounded, and balanced guidance.

Until now typical public company (Plc) boards were populated by executives of other companies, a distinct group with a lot of business and organisational experience but often facing perverse incentives. Family companies were often crowded with (what else?) family members. And start-up boards were often an incest ground for a few, very experienced and influential VC representatives with extensive cross-directorships.

I truly believe that we are entering the age of diversity, in this broader sense. Even the patriarchal families of the most conservative of EMs are beginning to understand this and invite outsiders to counsel them. Founders of small businesses understand that access to capital comes from inviting others to the decision-making table: these others bring diversity and diversity brings comfort all around.

But who are these others? In the core OECD markets a new breed of director is emerging and they are all about diversity. In fact, diversity is at the core of their career path. I call them the “portfolio directors”, some call them professional NEDs. Portfolio directors will increasingly be used in all types of companies, from the large PLCs (where their presence is already significant) to the small EM family businesses, often with the help of DFIs, the fourth driver. This latter trend is still in its incipiency but will grow significantly over the next 12 years.

The currency of portfolio directors will be their proven capacity to challenge constructively, which would be demonstrable through a successful track record as NEDs, not as executives in other businesses. Demonstrability will be based on the availability of data—the third driver. Discoverability of past performance will make NEDs less prone to being lapdogs of the controllers. We are not there yet, but this is an area where 12 years might make a lot of difference.

Currently, a phenomenon that is common in both the new age tech companies of Silicon Valley and the traditional family businesses in EMs is the presence of a King—an ultimate controller who can take decisions at will and for whom the board is either a legally imposed nuisance or a bunch of cheerleaders. Indeed, how is a Malinois or Peruvian business patriarch different from Mike Zuckerberg or Elon Musk? Well, their boards are full of the great and good and they are diverse, but only in terms of gender and, possibly, ethnicity. This is a step above than the patriarchs’ board of children, cousins and personal lawyers/consultants. But the reality of Big Tech leaves a lot to be desired: armed with multiple voting rights the Silicon Valley “kings” want boards to be “story tellers”—rather than drivers of challenge. Each one of these directors is hand-picked by the king and serves at the king’s mercy.

A better example of public market governance in the tech sector might come from the largest emerging market, China. Jack Ma has eased himself (and many of the first-generation executives) out of the well-known company he created less than two decades ago, Ali Baba. A couple of years ago, he relinquished the CEO position keeping the chairmanship. Now he has announced that he will be leaving the board all together. Compared to the Silicon Valley kings, he looks more like the Good Shepperd.

Reassuringly, most founders of tech start-ups that IPO in the US show the behaviour of Jack Ma rather than that of the “kings”, as recent research suggests. Most of these companies have already lost their founder from their board when they went public—not everyone wants to be king forever. This might however also be because companies take longer to IPO in recent times. The private part of the “food chain” is, these days, longer and often permanent. Let us consider one of its great constituents, the “unicorn” Uber.

In many respects “King” Kalanick was like the rest of his Silicon Valley peers—a big, intelligent ego, armed with significant multiple voting rights. But when he fumbled, he was driven out. His nemeses were not “independent” directors but representatives of significant shareholders, other than himself. Their voice was backed by the credible threat of loss of market confidence and impaired access to capital. I do believe that the private investment “food chain” that we discussed earlier, as opposed to the public route, has delivered such powerful, engaged shareholder directors, and will increasingly do so in the future. Unlike the public markets where boards essentially co-opt themselves, in the private equity context it is the shareholders, often several of them, who appoint the board. The principal-agent problem is less pronounced; hence governance risk is less acute. And as private finance becomes more and more ubiquitous in both core OECD and EM markets, the delivery of challenge in the private company board room will grow.

There is one more aspect of board room diversity that I would like to touch upon. Like in the case of multiple shareholder representation, it is more about the diversity of interests that the board focuses on rather than the diversity of its members. In other words, the importance of stakeholders is increasing and will increase even more in the coming 12 years. In some countries, like Germany, this has long been the status quo. But stakeholder power is now a prominent feature of corporate governance reforms in many countries. Germany is becoming a beacon for some important corporate governance reforms in other countries. Even the UK, the European bastion of shareholder value, has this year revised its venerable CG Code, the oldest of its genre in Europe, to include specific responsibilities for the board with regards to stakeholders. Boards now must consider employees and other stakeholders views when developing strategy and compensation plans and need to establish communication lines with their workforce. The era of unadulterated shareholder value that started in the 80s seems to be behind us. The markets are acknowledging this, albeit quite clumsily, through the rise and “mainstreaming” of Environmental, Social and Governance (ESG) screening and integration, and of “impact” investing. The pressure from investors will only encourage boards to consider stakeholder perspectives, even worker participation looks now like a distinct possibility in the UK.

But none of these trends could be sustained and become the future without disclosure.

Data

Data, the third driver, will increasingly fuel developments in the other three areas discussed in this post. As noted above, a key element of technology-driven disruption in many sectors is the availability of “big” data allowing companies to find niches and price their products with unprecedented precision. Such data will also help identify risks with a granularity that was not hitherto available to providers of equity and debt capital.

In the governance space, work is already under way. And while today data provision is focused on governance of banks (such as in the case of Aktis, a data provider that I chair) or large listed companies (such as in the case of Sustainanalytics or ISS) all existing data providers are considering ways to acquire, aggregate/anonymise and serve back governance data from and to private companies, providing benchmarking but also measurable “rankings” to potential investors.

The availability of data will also have a profound impact on the way boards work: for example, as compliance becomes automated, compliance data and logs will become a source of oversight for audit committees. Expanded use of board portals which are becoming the norm in many OECD core markets, will also provide board directors with better opportunities for deep dives into a company’s policy and control environment.

DFIs

I truly believe that in EMs, especially in frontier markets, the recent DFI commitment to actively seek better governance, a “conversion” of almost of Damascene proportions, has become a significant driver of change and will become more so over the next twelve years. IFC was certainly a trailblazer in this respect but others have followed closely.

A few years ago, the governance departments of most DFIs (some of them still nascent) started coordinating their approach to the governance of their investees. The IFC, the EBRD, the IDB, the ADB, and bilateral DFIs, such as DEG, FMO, IFU and Proparco, decided that they needed a common approach. Based on the IFC methodology, a DFI approach to governance was developed and endorsed. And DFIs now cooperate in continuously improving the methodology, in sharing experience from its implementation and even in carrying out individual investee engagements.

In 2018, KfW DEG, the German development bank, produced what will be considered a high water mark in the DFI space: The new Nominee Director Handbook. In my view it provides extensive ammunition in dealing with the still rudimentary governance in many of the boards its nominees sit on. By upping the game at board level, DEG nominees will produce significant results in many individual investees. But the most important impact is the positive externalities that might benefit all companies in the investee’s immediate ecosystem. These externalities will be multiplied significantly, because now DFIs “sing from the same hymn book” and collaborate on fostering governance changes.

Question:

According to "Corporate Governance 2030: Thoughts on the Future of Corporate Governance", List at least three changes in governance that you envision happening before year 2030. Do you agree with the author's perspectives? Why or why not?