Internal - Reward Value

With ‘internal governance’, we refer to the organization of stakeholder engagement, voice and supervision at the firm level. Currently, this ‘internal governance’ consists of rules and (best) practices regarding shareholder rights, the AGM, the behavior of non-executive directors, etc.

An open question is if and how other stakeholders could or should be incorporate in the internal governance of the firm and through what mechanisms this should influence compensation.

Currently, shareholders address their differences through several mechanisms. They can directly influence decision-making through engagement or ‘voice’ (e.g. electing non-executive directors, voting during the AGM), but they can also send signals to management through divestments/‘exits’. Both options are not available to broader stakeholders. They have no voting rights, nor can they divest as they have no ownership.

Engagement, voting and/or representation can be an efficient way to resolve issues of common agency. This suggests that one way forward could be to increase the representation of broader stakeholders in the internal governance of firms. Several options are available at various levels of control within the organisation. By including a broader group of stakeholders on the board, decision-making on compensation (but also: in general) could be more reflective of environmental and societal considerations ¹. At the level of the annual general meeting, corporate behaviour may be more strongly influenced if voting rights are extended more broadly to stakeholder interest groups or differentiated between investors seeking a short-term gain versus a long-term commitment.

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Systems

Corporate governance in a jurisdiction is very much determined by its history and political development. For ease of reference, two distinctly different systems with their characteristics are shown in the two tables here below. It concerns on the one hand, the outsider system, also labelled as the Anglo-Saxon governance system, which builds on the concept of liberal market economies like the USA and the UK. On the other hand, the insider system, also labelled the Rhineland governance system, which builds on coordinated market economies like Germany or Japan.

	Outsider	Insider
Ownership	Dispersed	Concentrated blockholders
Key conflict of interest	Principal - Agent	Principal - Agent + Principal - Principal
Voting power	One share - One vote	Multiclass shares/voting rights
Information asymmetry	High (mandated) transparency, quitable distribution of information	Distribution of information focussed on major shareholders
Coporate law protection	Stong minority stake provisions in corporate law	Weak protection for minority shareholders
Capital base	Skewed towards public capital/debt	Skewed towards private capital/debt
Controlling principals	Board of Directors, Institutional investors	Individual blockholders
Engagement	Mainly through exits	Mainly through voice

The second table outlines the strengths and weaknesses of these two governance systems.

	Strengths	Weaknesses
Insider systems (maximize blockholder value)	Relationship based Long-term orientation Better control over manager Engagement by voice	Conflict dominant – weak shareholders Weak investor protection Less-developed public capital markets Hostile takeovers rare due to shareholder control Value extraction by dominant shareholders
Outsider systems (maximize shareholder value)	Market based No conflict between shareholders Strong investor protection Well developed public capital markets Hostile takeovers as a disciplining mechanism on firm management	Short-term orientation Principle – Agent dilemma Engagement by exit Rent extraction by manager

Models

The third table here below describes two different models in corporate law, which are frequently debated nowadays. The shareholder model gained traction in the second half of the 20^th century, following the so-called Friedman Doctrine. The stakeholder model is gaining traction in the last decade in the belief that a company is a social institution. All those that are affected by a company, are qualified as stakeholders and their voices are to be heard / taken into account in the corporate decision-making process. Due to globalisation, the rise of institutional investor dominance and the inclusion of ESG factors (stimulated by the UN SDGs) in seeking a sustainable economy, a convergence of these models occurs and will influence the development of corporate governance in many jurisdictions over the coming period

	Shareholder model	Stakeholder model
Objective	Maximize shareholder wealth	Be socially responsible, acting in the public interests
Performance measure	Market value	Social- environmental impact
Orientation	(often) Short-term	(mostly) Long-term
Governance dilemma	Principle - Agent	Multiple Principles

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1. See e.g. Jager et al. (2020). Labor in the Boardroom.

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