The idea that a board of directors' sole responsibility is to maximize profits and ensure good returns for shareholders, as implied by "agency theory," is increasingly being challenged by the demand for corporate social responsibility (CSR) in which the concept of good corporate governance extends to include the impact of a company's policies over a wide range of social and environmental issues.
In their paper "Responsible Corporate Governance: Towards a Stakeholder Board of Directors," Silvia Ayuso and Antonio Argandoña address the question of how good governance relates to CSR. They challenge the assumption that good corporate governance focuses exclusively on the shareholders' interests and advocate a stakeholder approach in which the firm is viewed as a socio-economic organization that creates value for its multiple constituencies. They argue that, despite inconclusive empirical research, having diverse stakeholders on the board could promote CSR within the firm and increase "board capital" which may ultimately lead to a better financial performance.
The paper asserts that little academic attention has been paid to the implications of CSR for corporate governance and few companies have focused on board composition as a mechanism for considering stakeholder concerns. The central question the paper asks is how to ensure responsible corporate governance from both a CSR and good governance perspective. To the shareholder-focused concept of the board of directors, they propose a stakeholder approach and present a model for selecting board members on both ethical and pragmatic grounds.
They define a firm's stakeholders as "individuals and constituencies that contribute, either voluntarily or involuntarily, to its wealth-creating capacity and activities, and who are therefore its potential beneficiaries and/or risk bearers." Under the stakeholder approach, the governance structure shifts from a principal-agent problem to a team production problem. For a stakeholder firm to be viable it must demonstrate its ability both to achieve the multiple objectives of the different parties and to distribute the value in ways that maintain these parties' commitment.
Ethics and Economics
Ayuso and Argandoña cite Kaufman and Englander's use of the team production model to argue that board members should represent all the stakeholders who add value, assume unique risks and possess strategic information for the corporation. Shareholders must also be present because they can affect the firm's value via its share price and because the board is accountable to them both through financial markets and by law. For ethical and economic reasons, the board must have directors who can knowledgeably express the multiple stakeholders? interests. The question remains: How should they be chosen?
Most governance research argues for the need for independent directors. Independence is seen as key to the effectiveness of board monitoring. Under the resource dependence theory, which views the firm as an open system, dependent on external factors, the selection of outside members brings more resources, information and legitimacy to the board. It is argued that outside board members are more likely than insiders to oppose a narrow definition of organizational performance focused primarily on financial measures. It will tend to be more sensitive to society's needs.
The demand for greater boardroom diversity has given rise to the call for better representation by women and minorities on boards of directors to better reflect the gender and racial diversity of a firm's employees, customers and other stakeholders. Agency theory suggests that diversity increases independence and that diverse directors are less likely to collude with other directors to subvert shareholders' interests than more homogenous boards. By extension, it is argued that board diversity provides new insights and increases creativity and innovation. However, the authors point out that empirical research on the effects of gender and ethnicity policies on boards has produced mixed results. On one hand, some studies have found negative or statistically insignificant relationships between board diversity and financial performance. On the other hand, some studies affirm that female and minority directors are more likely to take an interest both in CSR and the needs of other stakeholders.
The authors argue that the role of stakeholder representatives is to enhance not only corporate financial performance but also and, more importantly, corporate social performance. Firms with stakeholders on their boards are visibly signaling their commitment to stakeholders. This can increase the firm's legitimacy and outside links, while the presence of stakeholders on the board increases what has been called "board capital," consisting of both human capital in terms of expertise and experience and relational capital (ties to strategically relevant organizations).
In order to differentiate among stakeholder types, the authors adopt the classification of consubstantial, contractual and contextual stakeholders. Consubstantial stakeholders are the stakeholders who are essential for the business's existence (shareholders and investors, strategic partners, employees). Contractual stakeholders, as their name indicates, have some kind of formal contract with the business (financial institutions, suppliers and sub-contractors, customers). Contextual stakeholders are representatives of the social and natural systems in which the business operates. They play a fundamental role in obtaining business credibility and, ultimately, the acceptance of their activities (public administration, local communities, countries and societies, knowledge and opinion makers).
The paper concludes that all three categories contribute to the firm's wealth and should therefore be represented on the board. Furthermore, the board should reflect social diversity. From an ethical standpoint, having stakeholder directors ensures that their rights and expectations are respected. From an economic perspective, a board that reflects the firm's internal and external stakeholders fosters their commitment and guarantees that business decisions will take their risks into account. Directors from a variety of constituencies will be able to provide important resources in order to assist the firm in creating and sustaining competitive advantage.
The authors challenge the assumption that good governance exclusively has to do with the interests of shareholders. They put forward a stakeholder model in which they demonstrate that corporate social responsibility and good governance, rather than being posited as opposing concepts, can and should be viewed as complementary principles.