Why Should We Care About Corporate Governance?

You're listening to Is Business Broken, a podcast from the Morrowtran Institute for Business, Markets and Society at Boston University Questrum School of Business. I'm Kurt Nickish. One of the goals of the Morrowtran Institute is to educate not just through research or in the classroom, but by creating real-world learning opportunities, experiences that help shape the next generation of leaders. So for this episode of the podcast, we're doing something in that spirit. We're handing the mic to one of our undergraduate students, giving them the opportunity to lead the conversation and pursue the inquiry. Before we start, I want to thank the Rife Dinch Cook Student Forum at the Morrowtran Institute for supporting this episode. The Forum fosters public dialogue on business and society through student-led podcasts and speaker events. Now, listen on and enjoy our special student-led episode. Hey everyone, and welcome to this student-led podcast episode of Is Business Broken from the Ravi K. Morrowtran Institute for Business, Markets and Society at Boston University Questrum School of Business. My name is Grant Corbett, a junior at Boston University and part of the undergraduate team at the Morrowtran Institute. I'm back exploring the major challenges shaping business markets and society today. Today we're joined by Roy Shapira, visiting professor at the Morrowtran Institute at Boston University Questrum School of Business, a senior fellow at Harvard Law School's program on corporate governance, and professor of law at Reikman University. Roy earned his doctorate in master's degree from Harvard Law School. His work explores how law and reputation shape corporate behavior, in other words, what really keeps companies in check beyond this regulation. He also writes widely on how boards are evolving to handle challenges in areas like corporate social responsibility, corporate culture and corporate accountability. Let's get started. Roy, thank you for being here. Thanks for having me, Grant. I'm going to be honest, we have a lot to cover, so we just get started with the obvious question, what is corporate governance? Corporate governance, you can body down to two words. Power and accountability or authority and accountability if you want. It's the system of rules and processes that dictate who inside a given company gets to direct the company, and how do we hold them responsible for the decision that they make. So we're talking about like in large companies, these are organizations that involve tens of thousands, hundreds of thousands, sometimes millions of individual, someone has to take the decisions. So we will have a CEO and she will take like the day-to-day decisions, but she will have to answer to a board of directors. Then the board of directors can decide that they want to fire, replace the CEO if she performs poorly, or alternatively give her a fat bonus if she performs well. In turn, the board of directors themselves are answerable to shareholders, to the shareholder meeting, to investors. And at least in theory, the shareholders can decide that they replace the directors if the directors are not accountable and so on and so forth. So we're talking about the system that dictates who makes the decisions, how they make them, and how they are being held responsible. You can think about it as sort of plumbing. You don't see it when it works well, but you definitely notice it when it doesn't. When there are certain catastrophes, you say, "Okay, here is the system of checks and balances. Here the system of corporate governance didn't work well." What are some examples of where corporate governance run wrong? If we look back, and we look back in point of time where there was an erosion of trust in the capitalist system or big financial crisis, you could always look behind the scenes and locate the corporate governance failures that led to it. So if you go back to the 2008 financial crisis, one of the biggest issue was executive pay, the way that these boards of directors or compensation committees designed the executive package for executives, incentivized these executives to take excessive risk. And the risk ended up blowing up not just in the company's faces, it ended up speeding over and taking down the entire economy with it. You go to the early 2000s, there was a wave of large accounting scandals with companies like Enron. And there, the biggest issues was with the external auditors, which normally we think that we will have those external auditors like accounting firms come in, and they are independent, and they are expert, and they verify your disclosions on your financial reporting. And there, there were many problems of conflict of interest. You can even go back to the 1920s in the Great Depression, where the problem there was a lot of companies just grew fast, but back then there was no system whatsoever of disclosures or oversight. In general, if you have a good system of corporate governance, it affects not just preventing internal breakdowns inside a given company, but also could prevent those speed overs that affect the real economy. Interesting. And kind of as you were talking, I was thinking about some recent headlines that we've kind of been seeing over the past few years. The one that kind of came first to my mind was, you know, Boeing. Boeing, starting with the Max-8s and the ongoing controversies that have kind of been going around. You know, they've kind of been playing a little bit of this game of, you know, how do we maximize, you know, shareholder value, how do we make it profitable, the financial side of things. But then also starting most notably in, you know, around 2018, 2019 with the Max-8 crashes that happened where, you know, people died, how is that, you know, related to corporate governance? How do you kind of describe how this established company kind of fails and the things that it's supposed to be the best at? When you adopt a corporate governance perspective, it allows you both in the Boeing 737 Max stories and in other stories like that to shift from what happened to how it happened. If you read the media coverage of these stories, you would find mostly details about what happened. You know, 360 people dead into airplane crashes, human tragedy of the mass, on a mass scale, technical failure in this huge airline manufacturing company. But if you adopt a corporate governance angle, it allows you to understand who let it happen and how it happened. How could such a massive technological debacle happen to such a supposedly good, well-established, reputable, strong company? The backdrop is competitive pressure. So Boeing pushed a certain product to the market and cut corners in the design of this new model 737 Max because they felt their major competitor Airbus, the French, breathing down their necks. And so they rushed that product to market without it being fully ready and they weren't fully transparent about it with the regulators and even with their customers, with the airline companies that bought the airplanes from them. So that's the first layer, but then you can go further deep because in a sense, the fact that management will rush to cut costs and maximize profits and maintain market share and cut corners with regulatory approvals, we kind of expect that to happen. In a certain way, we kind of incentivize management to do that. But precisely because we expect that to happen, we also have a system of checks and balances in place, we have institutions, corporate governance institutions that are meant to check and balance this managerial pursuit of profits. And the most classic institution that we already mentioned is the board of directors. And so from that angle, you can reframe the 737 Max story and the major question then will be, where was the board? Now, you could examine, you can try to answer this question and you can reach a conclusion saying, even the perfect board, even the most publicly spirited expert directors, could not have prevented this specific debacle in real time. The board is not omnipotent, but the process of trying to find out the answer to these questions or why it happened and who let it happen teaches you valuable lessons about how information flows inside the companies and what tweaks do you need to insert into the system of checks and balances to make sure that such debacles don't happen going forward. Wanted to bring in another contemporary example and talk about open AI and how they are kind of transitioning from potentially a nonprofit model to a for-profit model. How do you kind of explain what's happening there and like paint this picture of, you know, the other relationships going on behind the scenes. It's good because every example that you can think of of the top of your head of things that we hear in the news cycle, illustrates just how multifaceted corporate governance is. Because now precisely as you said, we're introducing new wrinkles. Now we're talking about the corporate forms. Up till now, we assume that companies are seeking to maximize profits and then the systems of corporate governance is kind of making sure that we don't hurt the long term and sustained performance and so on and so forth. Now with open AI, it started as and still operates under a parent company, which is a nonprofit. The system is geared not necessarily towards maximizing return on investment, but rather towards safeguarding a certain mission as the company scales up and as it faces stronger and stronger market pressures and maybe specific investor pressures. Do we really believe that it will stick to its mission and that it will prioritize safe AI over profits? So these are the kind of questions from the corporate governance perspective. And it sounds like there's this relationship between the shareholders and, you know, the stakeholders, the people who are outside of the organization who aren't potential investors, who are being impacted. That example the shareholders are, you know, obviously the investors in open AI, the people who have, you know, a monetary stake, some equity value. And then there are the shareholders or the stakeholders, excuse me, the people who are outside of open AI who are then impacted by the choices that open AI makes. Yeah, that's perhaps the biggest or broadest question in corporate governance is for whom those companies are managed. And you can adopt a very broad definition of corporate governance. If you go back to the beginning, we said that corporate governance is about the relationships between those who take the decisions and those who are affected by the decisions. But it doesn't have to be that those who are affected by the decisions are those inside the companies, like shareholders and employees. As companies go large and in the example of open AI grows larger and larger by the day, they affect, like you say, you know, communities outside of the company, they affect the product community, they affect could affect the environment, they affect the democratic discourse. And now the question becomes, how do you organize those corporate governance institutions that we mentioned, like executive pay or the board of directors, to make sure that those who make the decisions, do you want to make them accountable also to climate change? And if you do, how do you do that? That's not really intuitive. And so corporate governance touches all of these different areas of life. And it's this super important concept that kind of measures how companies are impacting the world around them. And I kind of was curious what is important to corporate governance. We've established that it's important, but what kind of drives corporate governance. So one layer to it that you could think of, and maybe this is my own background puts me in a bias here, but it's the legal duties. So you have kind of the floor, the minimum, the legal system sets the minimum duties that those who make decisions inside companies must operate by. We basically have two types of duties. We have a duty of care and a duty of loyalty for those who manage companies for directors and the officers. A duty of care basically means that you have to make informed decisions, you have to be prudent. And the duty of loyalty basically means that you have to put the company's interest first. You can't be in conflict of interest. But these duties, like we said, that they set the floor, they don't set the ceiling. And in many day-to-day decisions inside the company, those who make the decisions that don't necessarily have in mind front and center, is it legal? The usually just thing, is it good for business? What will it do to our reputation? The more important aspect is, so I'm making the decision in the company, and say that I get an opinion from the general counsel, the legal guys inside the company, they're saying it's legal. I still have a decision to make on not just what the judge will say about our decisions, but what our stakeholders will say in the sense of what our consumers will say, what our employees will say, what our investors would say. So this goes into kind of the reputational concerns that dictate our behavior. Even if a certain behavior is not punishable by law, and this prospect of diminished future business opportunities, push me to behave in a certain way. In that sense, the reputational concerns is kind of an informal enforcement mechanism, an informal corporate governance mechanism that complements the more formal legal system. And so that's kind of the things, you mentioned the line, the floor that the legal duties kind of operate at. There's some forces that you're describing that kind of operate above that line that kind of guide a company as it's going through. Could you describe a little bit more about what those forces are? If you talk about reputational concerns, people from outside the company, your customers, your investors, your lenders, your suppliers, they don't have direct access to information about your capabilities and your intention. And so they just take gather cues from how you behaved in the past and how you communicated them. And they form this perception of you in their mind, which is your reputation. And that dictates their willingness to pay premium prices for your products, or their willingness to invest in you, or if they land, then the kind of provisions that they want to put inside the contracts. And that's your reputation. And I'm sorry to be kind of skeptic here, but even that system, which sounds great on paper, of course, everybody wants to maintain good reputation. But even that system is kind of a very imperfect corporate governance mechanism, very imperfect enforcement mechanism, because there will be many types of behaviors where people outside the company will not necessarily know what happened. They will certainly not know how it happened and who is in charge of that mistake or this mistake. And in these kind of prevalent situation, the power of reputational forces is limited, or alternatively we live in an age where we have increased market concentration. So if in a given market you're faced by a monopoly, the power of reputation to discipline that monopolist company is limited, because reputation is about, I'm seeing that Grant is behaving in a certain way. I don't want to do business with Grant anymore. I'm switching to Grant's competitors. But if Grant is a monopoly, if Grant doesn't have competitors, so the power of the reputational system is limited. I want to kind of build a metaphor out of kind of all the things that we have so far. So we have the market forces. I want to visualize that as the sea, you know, you have these waves, you have tides, you have currents, you maybe have some legal duties and these things are like islands or rocks that you know are in the ocean, and they are kind of things that like if something hits them, then you know, that could completely sink the whole thing. And then, you know, the company being the ship in this metaphor, you know, the company is kind of, you know, operating through these tides, avoiding these islands, these kinds of things. What is driving the company? How does one ship, you know, differentiate itself from another? Right. So if I'm playing along with the metaphor, I think so far we've been focusing on things that happen outside of the ship or external forces. It could be external legal duties, it could be external market, reputational pressures. But, you know, on the ground, corporate governance is a lot of times a function of the internal governance structures within a company. So let's go back to one, maybe the most notable corporate governance institution that we already mentioned, which is the Board of Directors. Okay, so we have a Board of Directors, it's kind of at the epicenter of corporate governance. It doesn't make the day-to-day decisions, but it does set the strategy for the company, it hires and could replace CEO, designs the executive pay. And in general, overseas risks, as we mentioned already, as you could already see from the, even the examples that we mentioned, and other examples that are in the news, the Board of Directors in 2025, you know, I don't envy them, they have a very challenging role. If you, like, look at Tesla, okay, so now we have in the news Elon is seeking a pay package that could earn him, if the stock goes through the moon, Elon is going to earn $1 trillion. That raises the point of executive pay. And from a corporate governance perspective, again, just like we discussed with Boeing, it allows you to separate the more salient or sexy aspect of the story and the more relevant aspect of the story. Here, it allows you to separate the question of the level of pay from the question of the structure of pay. If you read it in the media, this will only be about the level of pay. But from a corporate governance perspective, more important is the structure of pay. Because this is what determines the incentives that managers have to steer the company to go back to your metaphor in a certain way. If the executive pay package incentivizes managers to maximize short-term profits or stock returns, that it could affect the company, it could lead to neglect of long-term investment in technology, it could lead to manipulation of certain observable logistics, it could lead to excessive risk taking, like we discussed with the 2008 financial crisis. If, on the other hand, the executive pay package is designed in a way that incentivizes sustained performance, then high level of pay is not necessarily a bad thing, it becomes a feature in the corporate governance system rather than a bug. Going back to your metaphor, it raises a deeper question, which is, who is negotiating this pay package with Elon? And now we're back with the board of directors. Are they independent enough? Are they willing and able to say no to Elon if they think that this is in the best interest of the company? These are the kind of challenges that boards are having, or if you go back to the Boeing example. The other question is not so much are they independent, but rather are they expert enough in the sense of do they have the deep industry knowledge and proficiency in certain technological aspect of the business that will allow them to ask the right questions to process the answers that they're getting and to anticipate future problems, things that they don't see on the PowerPoint deck that the CEO is presenting is delivering to them. And with Boeing, one of the issues that came up in retrospect was in the entire board, you didn't have a single director with expertise in flying airplanes or engineering or product safety. So again, kind of a huge challenge for a board of directors, companies in 2025 are much larger than in the past. They operate in an environment which is much more complex than in the past. How can a single board of directors, typically comprised of 10 people, typically meets just eight times a year? How can they have the independence and the expertise and the world we fall? To do all those things and to also ensure accountability, not just inside the company, but also how the company affects broader society. And something that I was thinking about while you were talking was, how does one get on the board of directors? Because when you were saying that no one at the time of these crises that Boeing was facing, that no one on there had any technical expertise, how did that happen? How is no one there? Because I would imagine that, you know, from my perspective, if you're getting on the board of directors, you have a lot of experience at this company, you've kind of risen to the ranks, you've kind of been voted on, you've been appointed to be a board of director, you have a lot of experience, a lot of expertise. How does one get onto the board of directors and the outsiders that just have different perspectives? Nowadays, most directors in large companies are so-called independent in the sense that they are not employees of the company. And historically, mostly they would come from a pool of either former or current CEOs in their 60s and their 70s, predominantly male CEOs in their 60s and their 70s that have experience in running businesses on a large scale. But given the recent changes in the ecosystem that companies operate in, in the recent, in the past five or six years, there have been a push to kind of change board composition and to nominate directors with specific subject matter expertise. So for example, people, whether it will be investors or regulates or academics, will come and they tell you, you know, a board of director of a large company in 2025, must have at least one director with expertise in cybersecurity, because cybersecurity is a major risk for any publicly traded company in 2025. And someone else might come and tell you, yeah, and the board of directors should also have someone with expertise in climate, or the board of directors nowadays should have someone with expertise in AI, or at least be proficient in AI. And it's a tough balance to have, because, you know, intuitively you could think to yourself, what could be bad about more expertise? Of course, we would want more expertise on the board, it's nice. But on the other hand, some counterintuitive dynamics to it, the more you bring on people with narrow subject matter expertise, you could lose some of the dynamics of the group as a sounding board, or they could be not as conducive to the many other things that are on the board agenda, like strategic foresight. And in a way, it could even hurt the specific cause that you're trying to promote. So if you're appointing someone to be the cyber expert or the climate expert on the board, it doesn't mean that the company will start to behave better on user privacy or on climate. In fact, it could mean that the other directors will suffer from so-called authority bias in the sense that they will say, okay, whenever we discuss cyber, I just, I'm shutting down and I'm just relying on what this perceived expert in cyber is saying. So not so clear how to design a board in 2025 to rise up to all these challenges that they're facing. Right now, we've kind of outlined, you know, these three different forces. We have the legal duties, we have the market forces, and now we just describe the corporate structure, the board of directors. Could we say which one of these is the most important for determining a company's success or just in terms of corporate governance, which one of these is the most important? Right. So I'm sorry to give you this lawyer like answer, but the answer is it depends. And we can't really give a categorical answer of this system is more important than that system. If I have to pinpoint what matters most in corporate behavior and corporate governance into one world, I would use the different world. I would use the word culture. What matters more than all those visible structural elements, what matters more is kind of the informal, unwritten norms and anyone for listeners who has been a part of a large organization, know that any given organization has their certain culture, has their certain DNA. And culture often dictates the outcomes more than the observable the architects and we have many examples, maybe the classic example is Wells Fargo involved in those huge cross selling fraud scandal. And Wells Fargo, if you analyze it in retrospect, you see that they have all the markings, all the trappings of a perfect corporate governance system. The board of directors is full of independent experience directors and they have an elaborate code of ethics and they invest a lot in their compliance departments and integrity trainings and so on and so forth. And all these observable the architects matter less when the culture, when the DNA, when the internal incentives, when you know that this is something that we don't report, just get the results, don't tell us how you got the results. When the culture is toxic, when the culture is flawed, all those observable structural elements of corporate governance matter less or if you go back to Boeing, there's a, I think it's called downfall, like a documentary on the 737 max crashes in Netflix. And the entire documentary focuses on the culture aspect and they have this theory whereby Boeing used to be the company of engineers. And then at some point in time, in the 1990s, they acquired McDonald Douglas, a company that had a completely different kind of profits above anything else culture. And the culture of McDonald Douglas took over the culture of Boeing and this is how we got into the download spiral that ended up with these catastrophes. So the first thing I'll say about what matters most is you can't tell, but probably culture matters more than the other elements. The second thing I'll say along the lines of it depends is that there is no single corporate governance recipe or system. It's effectiveness varies across industry, but also across countries. All those systems basically count down to the same question, which is how do we ensure that those with power over the corporation are being held accountable for their decisions? To the extent that the system manages to provide this accountability for those with power, it does its work regardless of how we tweak and move the furniture is around. We've been talking about all these different things, how things vary across the world and we live in very exciting times right now. And there's a lot going on in the world and I was curious, I want to get your perspective as an expert. What kind of keeps you up at night? What are you thinking about the most? So you're saying exciting times, this is like the Chinese proverb "May you live in exciting times, it's almost a curse" right? So I know that we may want to put some more optimistic spin on it, but I'm having a hard time, even the way that you've faced the question. So let me break it down into kind of a more optimistic spin and a more pessimistic spin. The more optimistic spin is go back to what we say in the beginning about corporate governance being the plumbing where you don't really notice it until something bad happens. So far every example that we mentioned is when you know what hit the fan and we know about it and we know that something bad about corporate governance happened. But in reality in 99.9% of the cases, corporate governance works well and it's precisely why we don't hear about it. So that's the optimistic aspect. The pessimistic aspect is I think that your question invokes the interesting times that we have in terms of trade wars and geopolitical tensions and inside each country political polarization and technological disruption on a mass scale and we're not sure what will be the ramifications. So even the best corporate governance inside companies would not be able to deal or to solve all these problems. It will help a given company handle them in a certain way, maximize its own returns in a certain way. But to make sure that we sleep well at night, we will need good corporate governance at the government level and at the global level. All right, Roy, thank you very much for your insights. Thank you so much for coming. Thank you, Gladys, and great. Thank you for listening to this episode of Is Business Broken. If you're a BU student interested in getting involved in the Mauritian Institute, please visit our website at ibms.bu.edu. [MUSIC PLAYING]