A corporate governance perspective

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The (ir)relevance of Accountability & Responsibility in Organizations? A corporate governance perspective Peter Verhezen Graduate School of Business and Economics, University of Melbourne Parkville Campus, Victoria, Australia Vlerick Leuven Gent Management School, Leuven & Gent Campus, Belgium Verhezen & Associates Ltd Sampoerna Square, Jakarta, Indonesia/Singapore

Abstract: The purpose of corporate governance is to safeguard the integrity of the promises made by firms to investors and other relevant stakeholders. Managerial wisdom – a continuous learning process that implies an amalgam of integrity, knowledge and experience – underpins the mechanisms of good corporate governance principles. Moreover, more often than not managerial wisdom has been “crowded out” by those same incentives and rules. Hence why the author argues that not more formal rules and regulations are required to manage and guide organizations, but less, while more managerial wisdom and appropriate incentives to motivate employees and managers should play a more important role. The integrity of board members remains central in those informal [and formal] governance mechanisms. Two specific notions within corporate governance will be analyzed: (1) how to re-interpret independency of board members that will enhance accountability and (2) how to understand and act upon the growing pressure on corporate leadership to be involved into corporate social responsibility. Managerial wisdom will only become relevant to organizations if it can re-assess and re-interpret

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particular power structures that steer accountability and responsibility measures. Managerial wisdom will need to “institutionalize” corporate governance guidelines that act to preserve and create sustainable organizational value.

Keywords: Managerial wisdom, Integrity, Best corporate governance practices, Informal and Formal Governance Norms and Rules, Accountability and independent directors, Responsibility and CSR

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This philosophical reinterpretation is inspired by Aritotle’s The Nicomachean Ethics and The Politics and some postmodern philosophers such as in J. Derrida, J. Habermas and H. Putnam who focus on the relationship between an epistemological truth seeking process and its ethical implications that may put some light on the good corporate governance notions of accountability and responsibility. In our narrower “operational” interpretation, integrity could have a direct positive impact on the firm’s performance, by providing a glue of trust and social capital (both informal rather than informal governance related mechanisms).

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“By discourse comes understanding By understanding comes light By light comes wisdom By wisdom comes wellbeing” Spilles et al, 2011

The capitalist market system nowadays seems to be characterized by the sins of arrogance, greed, untrustworthiness and callousness. Wise decisions – i.e. making “right” judgments that lead to good actions - may not be the most important goal of current business leaders. Practical knowledge and expertise through trial and error as in phronèsis therefore provides concrete solutions for specific organizational challenges, enshrined by a more holistic or whole perspective that highlights the importance of the different interrelationships within and across organizations and society. In other words, an inner voice or conscience [i.e. integrity] must permeate an organization’s processes to achieve organizational objectives of economic profit-seeking which itself should be intrinsically embedded within a more compassionate socio-ethical and environmentally sound framework. Organizations and corporate governance mechanisms should integrate [moral and environmental] values with [commercial] value, encouraging a crowding-in effect of integrity rather than emphasizing the crowding-out effect of purely pecuniary rewards. Wise corporate leadership is committed to serve a vision that is infused with a larger “common” purpose. This paper aims to indicate how the notions of accountability and responsibility, two pillars of corporate governance, will need to be re-interpreted to make more sense beyond smart public relations campaigns and to make those notions relevant for organization. Corporate leadership has been driven by pecuniary incentives within the boundaries of regulations and rules. The author’s hypothesis is that corporate governance is more about agreed promises than about contracts. Hence why the author argues that not more formal rules and regulations are required to manage and guide organizations, but less. Instead, managerial wisdom and appropriate incentives to motivate employees and managers should play a more important role in the decision process. The integrity of board members remains central in those informal [and formal] governance mechanisms. Two specific notions within corporate governance will be analyzed: (1) how to re-interpret independency of board members that will enhance accountability and (2) how to understand and act upon the growing pressure on corporate leadership to be involved into corporate social responsibility. Committed and spirited Boards and thus [wise] corporate leadership inspire and guide the organization, while at the same time monitor and supervise the [management of the] organization to secure the implementation of an enlightened purpose and vision aligned to profit optimization. Indeed, corporate governance mechanism and corporate leadership in charge of supervising strategic choices should integrate [moral and environmental] values

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with [commercial] value, encouraging a crowding-in effect of integrity rather than emphasizing the crowding-out effect of purely pecuniary rewards to top management for taking risks that pay off. The first introductory paragraph will explore the main features of what has been known as “Best” corporate governance principles. More specifically, we will first focus on the integrity of independent directors of a board as in being accountable to timely and accurate disclose of financial and non-financial reports to shareholders and investors. Furthermore, we will secondly explore the non-financial reported CSR activities that can be linked to an enhanced awareness of responsibility by corporate leadership to its shareholders and relevant stakeholders. Subsequently, we will attempt to incorporate the notion of integrity – an important pillar of practical wisdom in organizations – into “best” corporate governance “practices”. In the second and final paragraph we suggest that both the notion of ‘independency’ and ‘corporate citizenship’ (CSR / CR) needs to be redefined and re-interpreted by wise corporate leadership in order to make these notions of corporate governance more relevant for organizations. Independency as a state of mind may increase the accountability of a board to its shareholders, whereas corporate [social] responsibility could help the organization (1) to preserve value and the firm’s reputation in first instance and (2) to possibly create some of the future [sustainable] organizational value tapping into a changed and still rapidly changing mind set of customer and consumers. The re-assessment of accountability and responsibility may become a more effective beacon that permeates an organization’s process and that is incorporated in its “way of doing things”. Accountability and responsibility will be linked to integrity and managerial wisdom affecting the way we understand particular good corporate governance practices. The re-interpretation of Independency and “CSR” may therefore tip the organization toward becoming a genuine better corporate citizen.

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Corporate Governance safeguarding Accountability and Responsibility of Leadership How to understand the link between managerial wisdom, integrity as in honoring one’s word, and corporate governance? In order to understand that link, we will briefly elaborate on the generic principles of corporate governance, and specifically the notions of accountability and responsibility.

Integrity and Best corporate governance principles When the leader of an organization lacks integrity, the operational integrity of the system can be compromised and result in diminished performance. In an organizational context, to have integrity requires that the word of the leader, group or organizational entity can be trusted, must be whole, unbroken, unimpaired and in sound perfect condition. Somehow, one can re-interpret integrity in such a context as “honoring one’s word1” (Erhard & Jensen, 2010), because integrity has to do with the wholeness and completeness of a person’s word, and someone’s feeling. In other words, to be a person or leader of integrity one has to “honor one’s word” to oneself and to other people which means that one keeps one’s word and when one will not, then one says so and one cleans up any consequences. Corporate governance establishes who holds the [legal] power within the organization and how it can be used. Executives make decisions on a daily basis that are supposed to serve the organization. However, quite often those decisions may better themselves at the expense of other parties related to the firm: those costs are known as agency costs which find its roots in the separation of ownership and top management. A system of check and balances – the basis of corporate governance – is assumed to lessen those agency costs by controlling and monitoring top management. Indeed, the traditional agency theory of corporate governance sees the firm as a nexus of contracts between free and rational individuals optimizing their own interests (Friedman, 1970; Fama & Jensen, 1983; Jensen & Meckling 1976, Jensen, 1986; Lorsch, 2004). Corporate governance principles are justifiably considered as a needed check and balance system of top management of the firm who run the firm on behalf of the owners. The focus of corporate governance has been on how to maximize shareholder value with powerful top managers in charge who may have different objectives, causing an agency problem for the main shareholders (Huse, 2007; Wallace & Zinkin, 2005; Dimma, 2002). We here explicitly mention the Australian Stock Exchange Principles of good corporate governance2. Governance will not prevent misconduct or misdeeds, but it can actually improve the way a corporation is managed and possibly prevent some excessive threatening risks

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(Clarke, 2004 & 2007). One usually refers to successful companies that apply “best” [international] corporate governance principles. The incorporation of a firm leads to a nexus of contractual relationships in which a set of promises is made to investors, workers, suppliers, customers, local communities, and other stakeholders (Macey, 2008). Corporate governance is about how these promises are institutionalized or materialized, whether through law, contracts, norms or other more informal arrangements3. In essence, corporate governance is about building trust or keeping trust whereby the governance rules and regulations should strengthen shareholder’s contracting power within the firm and control possible corporate deviance from the contracts between the different participants, both investors as well as non-shareholder constituencies. How to minimize the chance that management or other participants would “violate” their promises to the investors and other relevant constituencies of the firm? The Australian Stock Exchange (ASX) Corporate Governance Council’s Principles of Good Corporate Governance (GCG) and Best Practice Recommendations stand out because of its clarity of expressing the essential characteristics and principles of corporate governance. Somehow, we believe that pursuing the objectives of the ASX GCG principles will likely result in (a) a reduced risk and (b) a better reputation or goodwill that functions as a valuable intangible asset for the firm. Moreover, ASX Best Governance “Practices” recommendations are often quoted as a benchmark for other Asian stock exchanges, and more particularly has been perceived as a yardstick for Singapore, Malaysia and Hong Kong – the current leading financial centers in SE Asia – in materializing corporate governance reforms. The ASX report identifies 10 main principles of GCG: (1) lay solid foundations for management oversight – recognize and publish the respective roles and responsibilities of board and management; (2) structure the board to add value – have a board of an effective composition, size and commitment to adequately discharge its responsibilities and duties; (3) promote ethical and responsible decision-making – actively promote ethical and responsible decision-making; (4) safeguard integrity in financial reporting – have a structure to independently verify and safeguard the integrity of the company’s financial reporting; (5) mark timely and balanced disclosure – promote timely and balanced disclosure of all material matters concerning the company; (6) respect the rights of shareholders – respect the rights of shareholders and facilitate the effective exercise of those rights; (7) recognize and manage risk – establish a sound system or risk oversight and management and internal control; (8) encourage enhanced performance – fairly review and actively encourage enhanced board and management effectiveness; (9) remunerate fairly and responsibly – ensure that the level of composition of remuneration is sufficient and reasonable and that its relationship to corporate and individual performance is defined; and finally (10) recognize the

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legitimate interests of stakeholders – recognize legal and other obligations to all legitimate stakeholders. From a shareholder perspective, effective governance should aim to increase the equity value by better aligning incentives between management and equity holders. From a stakeholder perspective or network perspective, effective governance should provide policies that produce stable and safe employment, provide an acceptable standard of living to workers, mitigate risks for debt holders, provide reliable products and services to customers, improve the community and acknowledge the importance of ethical and ecological objectives or constraints. Although both perspectives may not completely overlap, we believe that over a longer period, there should not be a contradiction between those two apparently opposing points of view. .Both formal and informal governance mechanisms will be emphasized in our analysis (Cf Figure 1). Internal [formal and informal] corporate governance mechanisms aim at (1) guiding the top management with strategy development to ensure the firm’s competitive edge and (2) using appropriate risk management tools to address possible risks that can endanger the corporation or create competitive opportunities, (3) taking full responsibility for appropriate internal auditing & monitoring practices and authorizing external auditing to verify financial reporting, as well as, (4) enhancing the relationship between the top management performance and their compensation package, (5) implementing a clear and well prepared succession planning and guarantee that the corporation creates a pool of possible leaders. More and more, a board and its management will also have (6) to monitor and react to the demands and expectations of relevant stakeholders, not just of investors but of all those who could affect the value of the company. The governance of corporations is effectuated not only through contracts, law, and norms but also through the complex set of relationships. Norms are an important source of actual legal rules; norms can affect behavior even before they become formalized as law (Macey, 2008). Formal governance mechanisms, for instance, – based on the mainstream Agency Theory - are the well-known and documented guidelines and practices as legally applied in most publicly listed companies in New York, London or Sydney. Those AngloSaxon common law countries usually provide better individual shareholder protection than the civic law countries (La Porta et al, 1999 & 2000). Informal governance mechanisms, however, are principles that emphasize the relationship of and between firms, and are mainly inspired by the Resource-based Theory and Institutional Theory (Verhezen & Morse, 2009) (Cf Figure1).

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Figure 1 1: Overview w of Formal and Inform mal Corporatte Governan nce Principlles

“Formal” ” External Legal Ins stitutional Control

Extternal Gove ernance Mechanisms GMs) (EG

“Informal” External Social No orms &Customs

Indepe endency & Board B Repre esentation

Own nership Conce entration Success sion Planning g

“Formal”” Internal Goverrnance Mechaanisms (FIG GMs)

Agencybased Intternal Corporate e G Governance & Sustainable Investment

Risk Managemen nt

Strategic c Steering g

Rules-Based G Governance = Best “GC” prractices

CEO/Ch hairman Struc cture

Firm Performanc

Trust-Base ed Values Resource-Based

CEO Compensation

“Informaal” Internal Goveernance Mech hanisms (IIG GMs)

Sociial Environm mental Facto ors

MacroEc conomic F Factors

Inter & Exte ernal Auditing g Netwo orks & Relationships Reputa ation

Direect control and influencce Indiirect control and influen nce

Organizational Culture

Sustainable Organizational Purpose/CSR

Source: based on an interpretation n of Verhezen n, P. & P. Mo orse, (2009), “Consensus oon Global Go overnance Principless?”, Journal of Internationall Business Eth hics, March, 2 (1): 84-101

Proposal 1: Internal Formal & Informal Corporate Governannce structurres and mechan nisms consstitute Good Corporatte Governa ance Mech hanisms. R Rule-based Agency Theory focuses on n formal go overnance m mechanisms whereas Resource-bbased Rela ationship hasizes the informal “go overnance” mechanism ms. Governance emph Corporate governance g e includes p practices th hat protect the assets oof the organ nization, al and finan ncial capita al, but it als so attempts to treasuree and enha ance the not justt its physica human and social capital of an a organizattion that pro ovides value to its ownners (Agraw wal et al, Beires et al, 2004; Bow wn et al, 200 06; Carver, 2010; Gillen et al, 20003; Lins et al, a 2004; 2005; B Lorsch, 2008; Norrdberg, 2011). Ultimate ely, tangible and intan ngible asseets – in the form of onstitute the e overall va alue of the organization o n. The Board is the reputatiion among others – co

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ultimate e steward who w suppos sedly takes care of the e organization and “steeers” it towa ard long term su ustainable organization o al value an d thus profiitability. es of Good d Corporate e Governan nce correla ated to Rulees, Incentiv ves and Figure 2: Principle Practica al Wisdom

Source: V Verhezen, P. & analysis on Practical Wisd dom based on n Boal et al (2000), McKennna et al (2009 9) and Verhezen n, (2009)

Propositio on 2a: Good d Corporate e Governan nce is direc ctly affectedd by the co ontextual combination of (1) formal ru ules and re egulations as a well as institutionaalized custo oms and ves and rew ward systems, and (3 3) managerrial wisdom (that is norms, (2) pecuniary incentiv constitu uted by virtu uous charac cter, the exp perience an nd capacity to act and to make ne ecessary change es, and the intellectual capacity to reflect and discern abo out the situaation) (Figu ure 2). on 2b: In the e Anglo-Saxxon busines ss context, manageriall wisdom may m have Propositio tradition nally been crowded out by the o overreachin ng pecuniarry incentivees and form mal(istic) rules an nd regulatio ons that focu us on comp pliance rathe er than on integrity Propositio on 2c & 2d:: Good Corrporate Gov vernance mechanisms m s aim (1) to monitor and con ntrol top management m t and the fiirm, and (2 2) to advise e and coachh managem ment (Cf Figure 1 & 2). Co orporate Go overnance a and its corp porate leadership how wever, will need n (a) ary incentive es and (b) specific s con ntextualized d rules and regulationss, and (c) ab bove all, pecunia manage erial wisdom m to be effe ective perforrmers.

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Based on the generic principles of transparency, accountability, responsibility and fairness, it can be argued that the board has two main specific functions to fulfill: (a) a controlling and monitoring function4 and (b) an advisory and coaching function. Good corporate governance (GCG) supposedly provides proper incentives for a board and its management to pursue objectives that are in line with the interests of the company and its shareholders (cf Figure 2). In other words, we can conclude that corporate governance is based on the principles of (1) transparency or openness, (2) accountability for one’s actions and fiduciary duties, (3) fairness based on integrity or ethical values and (4) being responsible for the reputation of the firm that can be affected by any relevant stakeholder (cf Figure 2). However, those generic principles need to be translated and contextualized in a national legal framework and corporate law. It also means that the apex of power lies in the hands of an able, committed and “independent” board that oversees and steers the firm to long term organizational value and profitability. The board should make sure that all shareholders are fairly treated and protect the rights of all shareholders, including minority shareholders, while legitimate concerns of particular relevant stakeholders and social obligations should be taken into account in making strategic decisions. It should be noted that corporate governance in its legal interpretation applies to publicly listed companies. Nonetheless, we believe that private non-listed firms could similarly benefit from implementing good corporate governance practices. We now turn to two specific topics within good corporate governance that interests us here: the notion of the board’s independency (a formal governance mechanism) and the board’s corporate responsibility (an informal governance mechanism) (cf Figure 3).

Example 1: “Wanted: an Independent Board” that controls & guides firms effectively for which it can be accounted for It is widely assumed in the Anglo-Saxon literature, one assumes that a majority of independent board members will counterbalance the power of top management entrenchment (Bown & Caylor, 2006; Cairnes, 2003; DImma, 2002; Fama & Jensen, 1983; Gordon, 2007; Jensen & Meckling, 1976; Klein, 1998; Larcker et al, 2011; Lev, 2012). Indeed, it is assumed that boards inevitably have close contact and proximity to management making it harder to remain “psychologically” distant and objective, leading to an anchored bias or “an inside view” (Kahneman & Lovallo, 1993). Independent board members supposedly will guarantee the legal protection of dispersed equity ownership – as the Anglo-Saxon capital market is characterized – or minority shareholder rights against the

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actual iinfluence and a power of o CEOs a and their top managem ment. It shoould be no oted that commo on-law firmss in an Anglo-Saxon context, us sually have e single-tierr board strructures, as civil-law companie es have offten a dua al-tier boarrd structuree consistin ng of a wherea supervisory (mon nitoring) bo oard and a manage ement (ma anagerial) board. Mo oreover, nance claim s that a ma ajority of ind dependent bboard members will mainstrream corporrate govern not onlyy reduce ag gency costs s but also im mprove the overall perrformance oof the firm. In other words, independence of boa ard memberrs are supp posedly sec curing som me accounta ability to investorrs and sha areholders. Nonethele ess, there does not seem to bbe any conclusive indicatio on that independent board b mem mber have a positive influence onn the firm financial f perform mance. Morreover, the increasing gly complex business s context aand the en nhanced scrutinyy of firms by a varietty of conce erned stake eholders, have h madee corporate [social] responssibility on to op of [legal] accountabiility an unea asy task for top managgement and boards. Figure 3: Principles of Good Corpora ate Govern nance with h a focus on Indepe endency (Accoun ntability) an nd Corporate e Social Re esponsibility y of Board members m

Source: V Verhezen, P.

Propositio on 2e: The e accountab bility (as in n the letter of the law w) of the board b is ed to be gua aranteed by y a majority of independent (non-e executive) ddirectors (Figure 3). assume Propositio on 2f: the responsibillity (as in the spirit of the law w) of the board b is expresssed in certa ain CSR acttivities of the e firm that assumedly a gives weighht to the concern of relevant stakeholders (Figure 3).

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Any organization is being controlled, ruled and guided by a board that has the ultimate legal authority of the organization which logically requires a high level of managerial and practical wisdom. Academics and practitioners alike do agree that one-size-fit-all would not work in corporate governance structures. Do we expect a global convergence of corporate governance practices5? Claims that corporate governance systems are currently undergoing a strong convergence are a little far-fetched in our opinion. Although it is true that weaknesses in Asian corporate governance systems were widely seen as a primary cause of the Asian crisis and the after effects, it is unlikely and not recommendable that Asian countries will adopt a variant of the Anglo-Saxon “outside” model. The prevailing Anglo-Saxon outsider model of corporate governance as practiced in the USA, UK, Canada and Australia is characterized by a high reliance on equity finance, dispersed ownership, strong legal protection of shareholders (including minority stockholders), strong bankruptcy regulations and courts, little rile for creditors, employees and other stakeholders in management, strong requirements for disclosure and high level of management discretion in mergers and acquisitions. This American-English model of corporate governance has been mainstream because of New York’s and London’s status of predominant international capital market which lead to the belief of an alleged ‘global consensus’ that corporate managers should act exclusively in the economic interests of shareholders. One assumed that by granting limited equity ownership [or stock options] to professional managers, one could reduce the agency problem since the managers would now be assumed to think alike owners and align their interests with the main shareholders of the firm6. Moreover, this outsider corporate governance model that has dominated international finance is based on the belief that the creation of liberal markets will facilitate the allocation of scarce resources in the most effective and efficient manner that consequently will lead to optimal economic outcomes. International “Western” capital and investment have logically followed this paradigm and shown the undeniable tendency for this mobile capital to locate itself in countries and firms that have efficient corporate governance systems. The recent global financial crisis (2008-2009) has definitely undermined this alleged superior corporate governance model. The “insider” model on the other hand so characteristic to German, Scandinavian and Japanese corporate governance has, indeed, gained some prominence since the financial mortgage debacle in the USA. This insider model is family-oriented or state-owned with long term focus that also emphasizes the community – as in an Asian economic context. Such an insider corporate governance model is usually characterized by a high reliance on bank finance, concentrated ownership, relatively weak protection of minority shareholders, a more

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predominant role of particular stakeholders in the ownership and management (creditors and employees in the German case), relatively weak disclosure requirements and more limited freedom in mergers and acquisitions. The question still remains whether a more independent board will guarantee the protection of all shareholders’ rights, and whether an independent board therefore can be perceived as more accountable to investors and shareholders. In other words, it is assumed that outside independent non-executive board members or directors have a relatively high integrity – their own reputation – to safeguard the implementation of governance principles in the organization, and guarantee fair, equitable and transparent treatment of all shareholders. Insider director, however, are assumed to be more entrenched with top management and its CEO, therefore forgoing the necessary monitoring role of the board, which might imply that the accountability and responsibility could be inferior to the independent board members. Institutional investors call for boards to have a substantial majority of independent directors. Indeed, those independent directors are assumed to have the managerial wisdom to guarantee appropriate monitoring of the top management activities. The powerful trend in favor of independent directors for public firms in the USA is influenced by (1) a shift to shareholder value as the primary corporate objective, and (2) the greater ‘informativeness’ of stock market prices as indicators of a firm’s performance (Gordon, 2007). In such a business context, outside independent directors are less influenced or committed to management and its vision. As the stock price becomes the main determining factor to measure a firm’s success, the internal perspective of management and its inside directors become less valuable. Through more disclosed and transparent information, and better compliance with the law, the firm’s performance can be allegedly better controlled by independent directors. Thus, the rise of independent directors should be evaluated in terms of this overall conception of how to maximize corporate and social welfare, and how to best protect shareholders’ rights (Morck et al, 2005; Gordon, 2007). Yet, there are numerous anecdotes and even studies where a highly independent board has not prevented large-scale wealth destruction. Enron – with 11 independent directors on its 14-member board – is an obvious and extreme example. It seems that the conventional wisdom favoring highly independent boards lacks a solid empirical foundation. Moreover, it seems that low-profitability firms in the USA respond to their business troubles by following conventional wisdom, i.e. by increasing the proportion of independent directors on their boards. However, there is no strong evidence and proof that this tactic would work. Moreover, firms with more independent boards – proxied by the fraction of independent or outside directors minus the fraction of inside directors – do not achieve substantial and sustainable improved profitability, and in some instances they even underperform compared to other firms (Bhagat et al, 2002). Studies in Australia, Singapore and the United Kingdon also reveal facts that

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counter the conventional wisdom of favoring independent boards (Faccio et al, 1999; Lawrence et al, 1999; Mak et al, 2001 all quoted in Bhagat 2002). Moreover, there seems to be some evidence that CEO compensation correlates positively with the compensation of the outside “independent” directors, and only negligibly with the CEO’s performance (Lev, 2012). Usually, bending to external pressure to take on more independent directors does not bode that well, and it is hardly an effective answer to improve the firm performance. In other words, there are hints that greater board independence - conform to the conventional managerial wisdom – does not improve performance; on the contrary, it seems to impair firm performance (Bhagat et al 2002). We could argue that inside directors could add enormous value while a mix of inside and outside directors – and possibly some affiliated directors – could bring different skills and knowledge and thus managerial wisdom to the board. Moreover, insiders also may outperform outside directors in terms of strategic planning decisions because of their intimate expertise and specific knowledge of the firm. Independent board members can add real value to the organization (1) if they are embedded in an appropriate committee structure, (2) if they have specific expertise and the integrity to honor their promise to guide and monitor top management with the aim of long term sustainable value. Proponents of board independence should be aware that observations seem to indicate the existence of a negative relation between board independence and future operating performance (Bhagat & Bolton, 2008). Making board more independent to guarantee improved performance may be grossly overrated and misguided. However, it can be argued that independent boards are usually slightly more effective in disciplining management of poorly performing firms, compared to insider board (Bhagat & Bolton, 2008). Some may even claim that the independent directors may be best suited for performing the monitoring and controlling [formal governance] function of a corporate board, while the inside and affiliated directors may be quite useful in advising and coaching top management – the informal governance mechanisms. In other words, conventional wisdom will need to re-interpreted to be more useful and effective. If the purpose is to optimize the organization’s performance, then not independence but the greater stock ownership by the board (Bhagat & Bolton, 2008) may help to improve the monitoring and advisory role of board members on guiding and enhancing the organization’s performance.

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Example 2: “Wanted: responsible boards” who take the concerns of stakeholders seriously Corporate responsibility and its social implications for the community at large have long been a point of controversy among business people and economists. Business is perceived to maximize profits and CSR is therefore often perceived as a dilution away from the prevailing shareholder value focus (Friedman, 1970; Henderson, 1999; Beard et al, 2011). Most firms interpret CSR as either a misguided social program or a necessary cost to do business. Lately, business starts to think about CSR in a more benign way and perceives some possible business opportunities of CSR, albeit it remains separated from most business strategies and is interpreted as a “cost” rather than an investment. The debate is far from over, mainly because the notion of CSR is an evolving concept itself (Carroll, 1999 & 2010; Mele, 2011; Surroco, 2010; Siegel, 2007; Verhezen, 2012). How then to interpret CSR and the board’s “responsibility” to concerned stakeholders? The last two decades CSR became more and more interpreted as a “License to Operate” in a particular community (Carroll, 2010; Porter & Kramer, 2006; Kakabadse et al, 2007). In other words, CSR was not really seen as engrained within the strategy of a firm but rather as a possible way to secure the goodwill from external relevant stakeholders, securing an underlying “social contract” from the community in which the firm was operational. It is this logic disconnect between the internal realities of a firm and the external stakeholder demands upon business that has created the tension and trade-off idea between pursuing strategic goals that is driven by maximizing shareholder value on the one hand and taking into account some not-to-ignore-stakeholder-demands on the other hand (Jensen, 2002; Vogel, 2005; Zadek, 2004; Werbarg, 2009). Although CSR cannot be ignored these days, the notion is merely seen as a tactical way to gain goodwill from stakeholders. I have argued elsewhere that CSR only makes business sense if it is strategically embedded to preserve organizational value as in an insurance policy against crises, and to a lesser extent as value creation in particular niche markets (Verhezen, 2012). A corporation displays social responsibility when it engages itself in processes that appear to advance general or contextual social and or ecological agenda beyond mandatory legal requirements (Siegel & Vitaliano 2007). Those CSR processes are predominantly of an intangible nature, aiming to generate reputational capital, improved corporate culture, legitimacy or loyalty within the business community. Only a few cases of CSR initiatives result in tangible assets such as eco-efficient production technologies. Consequently, most corporate investments of (cash) resources in CSR are considered as accounting expenses rather than investments, creating an “accounting illusion” (Hoepner et al 2010). If values, beliefs and shared ways of doing things affect behaviour, organizational culture functions as the DNA of the firm’s decision making process (Prahalad & Bettis 1986). Moreover, with the

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rise to power of institutional investors – shifting corporate control back to owners from managers – [the demand for more] accountability and responsibility of and within firms is growing. As long as CSR is perceived as a necessary activity that may enhance the reputation of the firm, one can hardly speak of a genuine attitude of responsibility, rather a way to placate concerned stakeholders. Only when CSR and corporate responsibility is engrained in the daily decision-making, it can become a strategic force. Such a change will require a different approach to C(S)R, and a re-interpretation where accountability and responsibility drive corporate responsibility activities. Such a choice will require a new more holistic form of managerial practical wisdom where CR is not bolted on the firm to seduce stakeholders of their sincerity, but genuinely built in the DNA of the firm’s decision-making processes.

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Re-interpretation of Accountability and Responsibility embedded within managerial wisdom Independency is a state of mind, not a compliant tick the box activity. Being accountable is more than a compliant accounting exercise reducing possible legal liabilities, though such a minimum mandatory complying to the letter of the law could well be satisfactory to most business people. However, being accountable in the spirit of the law, may require more than mere liability compliance from board members. Similarly, if corporate responsibility – a more voluntary act on behalf of the firm – remains a form of enlightened public relations, it will hardly achieve the genuine telos or objective of what wise leaders would aim for. If corporate leadership aspires to gain back the trust of the community – after the disastrous and often debilitating crisis of 2008 till present – one may want to take integrity of leaders and organizations seriously. Only when real wisdom will start to play a role in management decisions, corporations will be part of a solution to address the global challenges. If not, due to a lack of managerial wisdom, firms will be mere vehicles to optimize shareholder value at the expense of ethical and environmental objectives. Admittedly, it is not the main task of firms to resolve all sustainability and ethical issues in our society, but it cannot be true either that firms aggravate the situation. The minimum one can expect from any wise leadership is that they do not harm, be fully accountable for their decisions and actions, and that they take their social and moral responsibility within the boundaries of reasonableness.

Re-interpretation of independency as a state of mind As long as “independency” is, indeed, misperceived as a compliant-tick-the-box effort, the objectives of safeguarding the shareholders’ rights to optimize sustainable organization value will not be met. Wise leadership – both on the regulatory as on the corporate side – is well aware that independency is a state of mind while acknowledging that some minimum legal requirements may be helpful. However, believing that legalizing human, in casu board, behavior through rules and misperceived incentives could achieve some desired goals may result in badly spend organizational resources and can even harm the organization and its environment. There is no convincing evidence that greater board independence correlates with greater firm profitability or faster growth (Bhagat el al 2002; Gordon, 2007), or even protects minority shareholder rights. Contrary to the conventional wisdom on corporate governance, one may even suggest that supermajority-independent boards are less profitable and less

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effective than other firms. Moreover, affiliated directors seem to have a positive effect on the return on investment and stock market performance (Klein, 1998). Inside or non-independent directors may be more “conflicted” than outside independent directors, but they are usually better informed and often more committed. Perhaps independent board members will act more quickly than inside directors if something goes wrong. However, inside directors have the huge advantage of having access to “inside” information that could allow better decision making. A collaborative board with a small but committed minority group of inside directors improves board decision-making due to their superior information (Westphal, 1999). Although inside board members may lack independence, they have their human capital, and often most of their financial capital, committed to the firm, making them formidable contributors and committed advisors to the firm. Such board members with substantial stock ownership act more quickly to replace a non-performing CEO (Bhagat, 2002; Lev, 2012). Management-friendly boards can be more optimal because they increase the quality of the advice that directors or board members provide to managers (Adams et al, 2007). Boards that are genuinely guided by practical wisdom, perceive independence as a state of mind, not a legal compliance issue. The reliance on the integrity of all those board members – either insider or outsider director – will likely produce superior results than a mere tick of the box compliance to a status of independency. One cannot ignore the fact that a board remains a collegial decision-making body (Charam, 2004, 2009; Macey, 2007). Maybe independent directors are not independent enough, and need to enhance their commitment to the firm, while also acknowledging the advantage of having inside practical knowledge that could be wisely used to provide management access to valuable intangible assets, and to closely monitor top management with the aim to superior results. Proposition 3: the more committed board members are in terms of human and financial capital, the more they will speak out their mind in an “independent” way. Proposition 4: insider and affiliated board members with specific and or intimate expertise of the industry, should be allowed to sit on a board, effectively advising and coaching top management. Proposition 5: outside non-affiliated board members with specific expertise in accounting, finance and remuneration, may be useful board members within specific and necessary (Audit, Remuneration) committee to safeguard the shareholders’ rights and to control and monitor the financial performances of top management. Proposition 6: a combination of affiliated and outside directors should emphasize the importance of responsibility and guarantee policies, strategies, processes and procedures to secure the reputation of the organization.

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Re-interpretation of corporate responsibility as a concerned attitude As long as firms view ethical business and CSR as a kind of compliance to the pressure of powerful and potentially hurting stakeholders, business leaders do not tap into the enormous power of motivation to go beyond mere reacting to external pressure, either by law or by fear of particular stakeholders. Nonetheless, it would make strategically a lot more sense when companies would start to be more proactive and view CSR as potential value creators, not a mere reaction to please or to ease external forces (Porter & Kramer, 2006). Obviously, we believe that CSR is more than being involved in philanthropic and other social activities (Verhezen, 2009 & 2012); it can be perceived as an attitude found in the culture of the organization, especially when corporate responsibility is aligned with some social aspects of the firm’s activities. In order to make CSR part of the inherent culture and values of the firm, it will need to be integrated and aligned to the core strategy, driven by systemic objectives of sustainable development that go beyond the organizational financial objectives (Werbag, 2009; Stone et al, 2002; Orsato, 2009). Such systemic integration and alignment will need a re-interpretation of corporate responsibility and the meaning behind a firm and its management decisions7 (Bozinck et al, 2010; D’Amato et al, 2009). Corporate responsibility could be perceived as relevant to business when (a) it creates strategic value to the firm, and (b) it preserves value in case of crisis (Verhezen, 2012). The business case of CSR, widely publicized in the glamorous notion of “shared value creation”, aims at “doing well by doing good”, possibly trumping competitors (Porter & Kramer, 2011; Godfrey et al, 2009; Argandona, 2001, Beard, 2003; Benabout, 2010). However, CSR as risk management may be even more powerful as it operates as an insurance policy mitigating negative events or mishaps and building crucial social capital shielding the company to some extent from public sanctions and other adverse consequences (Figures 4). Corporate responsibility – which should not be legalized or made mandatory – can become a way to holistically address economic challenges by incorporating economic and environmental objectives (Werbag, 2009; Verhezen, 2012). However, it should be clearly understood that such holistic approach should not be at an enormous expense of quality and price of the products and or services offered. Currently, quite a number of researchers argue that despite the enormous interest from consumers to buy green or ethically inspired products, it remains a niche market (Vogel, 2005; Waddock et al, 2004), unless the price becomes so competitive with the traditional products that the choice becomes a no-brainer. Only when corporate responsibility has become part of the firm’s DNA in a systematic way, without jeopardizing or trading off any of the core competencies or productivity goals, the firm has a chance to sustainably succeed. Only when the corporate responsibility has

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been systemically engrained in the core business activities of the firm, it makes business sense to “align” strategy and CSR. As a matter of fact, one does not “align” but incorporate the values of the firm [to be ethical and sustainable] into the production value chain of the firm. When corporate responsibility has become part of the “organizational system”, when CSR has gone beyond an add-on but has been systemically engrained into the organizational culture and values, corporate responsibility that is linked to a kind of collective responsibility or larger public good may become relevant in a sincere and “sustainable” manner. If not re-interpreted, corporate responsibility remains a fashionable fad without any substantial content or effect on the insight decision-making of board and top management.

Proposition 7: affiliated, insider and outsider board members should emphasize the importance of corporate responsibility to secure the reputation of the organization, and to align financial with non-financial objectives. Proposition 8: it is reasonable to assume that the responsibility of the organization is measured in terms of a return on investment to increase possible activities in CSR, while the no-harm rule remains in place.

Effective “wise” boards that are ‘objectively” accountable and “intrinsically” responsible Most likely, a firm will only take its responsibility and will only be accounted for, when its leadership installs the procedures and internal governance mechanisms to guarantee that the organization is doing the right thing, and doing it right as well (Figure 5c). The board will need to secure the “objective” accountability and “sincere” responsibility of the organization. It is this combination of reasonable objective accountability for one’s actions in business and the sincere intention to be responsible for the firm’s activities in its broader environment that constitutes truthfulness. This notion of truthfulness that through experience – based on an open mind to continuously learn - is practiced in daily managerial decision-making leads to managerial wisdom. Hence the importance that also board members will be accounted for their own supervisory and advisory functions within the organization. Moreover, the board holds the ultimate [legal] power of the organization to make or break those promises. Integrity as in honoring one’s word and promises (in vision and values statements) – i.e. the narrower operational interpretation of integrity - will need to become part of the DNA of a board functioning. Only then, trust will be regained, and the informal glue will help companies to

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move o on in produ ucing neces ssary good ds and serv vices in a more sustaainable and d sound mannerr. Figure 4 4a: Board In ntegrity and d Compliancce in an unc certain business contex ext

Source: b based on Verh hezen, P., (2010), “Giving V Voice in a Cultture of Silence e”, JBE, Springg

4b: Accountability and Responsib ility Figure 4

Source: V Verhezen, P.

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Figure 4c: Re-inte erpretation of Board In ntegrity in an a uncertain businesss context, enabling e strategic opportuniities and pre eventing thrreatening risks

Source: V Verhezen, P.

It is the boa ard’s fiducia ary duty to itts shareholders to gua arantee trannsparency, fairness, f accountability and responsibiility, the ma ain pillars of o good corrporate govvernance prractices. Withoutt understan nding and re-interpreti r ing those four f generic c principless [of transp parency, accountability, ressponsibility and fairne ess] and without w them wisely ttranslating and or transforrming them into a specific busine ess context,, these governance prrinciples will remain nice slo ogans with hout any re eal substan ntial impac ct on the ruling r and functioning g of the organizzation. e box appro oach to goo od corporate e governancce will not inspire a Obviously, a check the true se ense of eth hical obliga ation. The former 200 03 Aetna chairman c W William Don naldson, subsequently served as chairrman at the e SEC for tw wo years, eloquently exxpressed th hat such n array of inhibiting, i politically p coorrect dictates. […] mere compliance would just “lead to an are vast diffferences in the function n, structure,, and busine ess mandatte of the tho ousands There a of corp porations struggling s with w the is sues of good corporrate governnance” (qu uoted in Sonnen nfeld, 2004:: 112). There is no on ne answer or o one approach to wiise good co orporate governa ance practices. A con ntinuous re -interpretation to the specific [buusiness] co ontext is needed d; only wise e leadership p allowing an open discussion within w the oorganization n will be

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able to contribute to create, preserve or enhance sustainable organizational value. Boards need to guide top management to enable strategic opportunities and to prevent threatening risks to materialize which can significantly damage the firm (cf Figure 4). Integrity and authentic leadership – as part of managerial wisdom – cannot be kept within the firm frames of rules and incentives, which may even crowd out the sought wisdom. Practical wisdom8 acknowledges the importance continuous [moral] learning and non-ending discourse to embrace the dynamics of complexity and ambiguity that also incites the opportunities of dynamic innovative solutions for our even more challenging complex [business] reality. Such wisdom is only the beginning of a desirable process [of learning], not an end or goal or technique. Proposal 9a: Managerial Wisdom or practical wisdom relies on the notion of truthfulness, that is the summation of intentional sincerity2 (or trustworthiness) and professional accuracy (or describing perceived factual objectivity). Hence why, phronèsis or practical wisdom is a learning process of values and knowledge that finds its integrative roots in experience and integrity3. Proposal 9b: Accountability and Responsibility, two pillars of GCG, rely on managerial wisdom – integrity, knowledge, and experience – to have a real effective impact on power structures and organizational performance.

2

Intentional sincerity or trustworthiness in fact refers to the notion integrity, honoring one’s word; and professional accuracy refers to experience, expertise and specific knowledge in the organization. The combination of integrity and professional experience unfolds to truthfulness. Truthfulness is the activity or process to possibly results in wisdom. 3 Integrity as in honoring one’s word (including dealing with the impact for not fully [able to] keeping one’s word) will enhance the informal relationships within and between organizations and improve the effective performance of an organization. Integrity as an objective virtue in conjunct with self-awareness and a higher objective beyond self-interest constitute practical managerial wisdom, i.e. managerial phrónèsis.

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Conclusion: Wise Leadership that is accountable and responsible Business has been driven by pecuniary incentives within certain regulatory boundaries and rules to incite innovative and efficient corporate behavior that results in profitability as a return to the investment made by shareholders. However, managerial wisdom has hardly been perceived as a constitutive and thus relevant factor in achieving economic value for the organization. Nonetheless, good corporate governance is more than complying with rules and regulations or to install pecuniary incentives to motivate management to pursue profitability. It is argued here that an re-interpretation of some corporate governance notions will be needed to achieve the desired [economic] results. From the four generic corporate governance principles – transparency, accountability, responsibility and fairness – we have distinguished, this paper has focused on accountability and responsibility of the board. The independency of board members for example is not an exercise of mere legal compliance to accountability to shareholders but rather a state of mind that implies that board members adhere to the notion of integrity that assumedly honors their fiduciary duty. Similarly, responsibility is not bought with a mere PR exercise of CSR activities or corporate philanthropy. The hypothesis here is that being accountable for its legal and fiduciary contract to the shareholders and being responsive and responsible to the demands of the community in which the firm is operational will need to reinterpreted and inspired by the constituting characteristics and features of practical wisdom, among which a narrow operational view of the notion of integrity. Quite often, integrity has been crowded out by pecuniary incentives and mere formal rules and regulations (within corporate governance practices) that have not prevented alienating effects. Moreover, those rules and incentives were partially at the root of the current crisis. If management remains a mere technè – i.e. a technical tool as often taught at Business Schools to achieve purely accounting profitability – it never will be able to genuinely motivate leaders and employees to create sustainable value9. Managerial wisdom or phronèsis is an amalgam of (1) integrity and values, (2) knowledge, and (3) [professional] experience, (4) fueled by a continuous process of learning that reflects upon what is “the right thing to do, always”. Wise leaders can provide the context and role model for everyone in the organization to become “wiser” and therefore most likely more effective and efficient. Committed and spirited leaders communicate with their subordinates. They set clear ethical standards, and use rewards and punishments to see those standards followed.

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Wise leadership10 knows how to collaborate with the numerous relationships within the firm and between organizations that constitute the basis for transactional economic value. Moreover, authentic leaders are most often quite true to themselves and deploy high levels of [moral] integrity. That makes them trustworthy or sincere11 which along with a sense of objective reasonableness is needed to be truthful – a proxy to understand reality. The process of continuous learning that accommodates the dynamic notion of truthfulness and intelligence, aligned with values and integrity, and experience and capability to make changes will result in a form of managerial wisdom. Indeed, authentic leadership that incorporates integrity in its decision-making acknowledges the importance of a continuous learning how to address ethical and environmental challenges while preserving or enhancing the economic value of the firm – justifiably still the priority of the board and its shareholders. Nonetheless, wise and integrative leadership transcends the conventional trade-offs between an economic reality and the different ethical and environmental demands. An effective leader does not necessarily lead by control only, but rather by vision and conviction and a willingness to be accountable for his management decisions to the board while also taking full responsibility for the consequences of the firm’s activities to relevant stakeholders. Committed and spirited Boards and thus [wise] corporate leadership inspire and guide the organization [emphasizing the relationship and resource building], while at the same time monitor and supervise the [management of the] organization [based on clear standards, rules and incentives] to secure the implementation of an enlightened purpose and vision aligned to profit optimization. Indeed, corporate governance mechanism and corporate leadership in charge of supervising strategic choices should integrate [moral and environmental] values with [commercial] value, encouraging a crowding-in effect of integrity rather than emphasizing the crowding-out effect of purely pecuniary rewards to top management for taking risks that pay off. Unless integrity and authentic leadership may shape the practices within and between organizations, and is “incorporated” into “best” corporate governance practices, managerial wisdom will remain a distant corporate ideal at best, or completely irrelevant to organizations possibly wasting valuable resources and or likely harming external stakeholders. Values and a higher purpose beyond mere accounting profitability build a strong culture. Economic profitability is the consequence of “wise” decisions that align financial and non-financial motivating objectives. Integrity – in both its narrower operational and broader philosophical interpretation – should not be crowded out by [governance] rules and incentives, but should remain a pillar of managerial wisdom that functions as the underlying “spirit” of institutionalized good corporate governance mechanisms. Only then will wisdom in organizations have real relevance.

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Appendix - Figures

Figure 1: Overview of Formal and Informal Corporate Governance Principles Figure 2: Principles of Good Corporate Governance correlated to Rules, Incentives and Practical Wisdom Figure 3: Principles of Good Corporate Governance with a focus on Independency (Accountability) and Corporate Social Responsibility of Board members Figure 4a: Board Integrity and Compliance in an uncertain business context

Figure 4b: Accountability and Responsibility

Figure 4c: Re-interpretation of Board Integrity in an uncertain business context, enabling strategic opportunities and preventing threatening risks

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Footnotes 1

See Erhard & Jensen, 2010 & 2011. In Professor Jensen’s model, integrity is re-interpreted as honoring one’s word, defined as : 1) keeping one’s word (and on time), and, whenever one will not be keeping one’s word: 2) just as soon as one becomes aware that one will not be keeping one’s word (including not keeping one’s word on time) saying to everyone impacted (a) that one will not be keeping one’s word, and (b) that one will keep that word in the future, and by when, or that one won’t be keeping that word at all, and (c) what you will do to deal with the impact on others of the failure to keep one’s word (or to keep it on time). Honoring one’s word (1) provides an unambiguous and actionable access to the opportunity for superior performance and competitive advantage at the individual, organizational and possibly social levels, and (2) empowers the impact of ethics and legality even more. 2 A 2nd concrete good example of good corporate governance is the OECD principles. The OECD published its Principles in 2004 defining good corporate governance as a set of relationships between a company’s management, its board, its shareholders and other stakeholders. Corporate governance not only provides the structure through which the objectives of the company are set, but also the means of attaining those objectives and the ultimate organizational power to monitor performance of the organization. The OECD’s Corporate Governance Principles prescribe that a corporate governance framework should ensure the strategic guidance of the company, the effective monitoring of management by the board, and the board’s accountability to the company and the shareholders. Indeed, corporate governance can be perceived as the collection of control mechanisms that an organization adopts to prevent or dissuade potentially self-interested managers from engaging in activities detrimental to the welfare of shareholders and stakeholders. The OECD set for GCG contains the following basic principles: (1) Ensuring the Basis for an Effective Corporate Governance Framework - the corporate governance framework should promote transparent and efficient markets, be consistent with the rule of law and clearly articulate the division of responsibilities among different supervisory, regulatory and enforcement authorities; (2) The Rights of Shareholders and Key Ownership Functions - the corporate governance framework should protect and facilitate the exercise of shareholders’ rights2; (3) The Equitable Treatment of Shareholders - the corporate governance framework should ensure the equitable treatment of all shareholders, including minority and foreign shareholders. All shareholders should have the opportunity to obtain effective redress for violation of their rights; (4) The Role of Stakeholders in Corporate Governance - the corporate governance framework should recognize the rights of stakeholders established by law or through mutual agreements and encourage active co-operation between corporations and stakeholders in creating wealth, jobs, and the sustainability of financially sound enterprises; (5) Disclosure and Transparency the corporate governance framework should ensure that timely and accurate disclosure is made on all material matters regarding the corporation, including the financial situation, performance, ownership, and governance of the company; and last (6) The Responsibilities of the Board - the corporate governance framework should ensure the strategic guidance of the company, the effective monitoring of management by the board, and the board’s accountability to the company and the shareholders 3 See Macey, 2008; Colin, M. & H. Hirt, Corporate Governance and Performance, Hermes Pensions Management Ltd, Dec: http://www.hermes.co.uk/corporate_governance/corporate_governance_and_performance_feature.ht m#definingcorporategovernance. Corporate governance refers to corporate decision-making and control, particularly the structure of the board and its working procedures. However, the term corporate governance is sometimes used very widely, embracing a company’s relations with a wide range of stakeholders or very narrowly referring to a company’s compliance with the provisions of best practices codes. 4 See Verhezen 2009; 2012. One of the main functions of a board is, indeed, to effectively monitor top management whether they execute their fiduciary duty to optimize in interests – usually summarized in the return of investment or profitability - of the organization and thus its owners. The fiduciary duty of a board usually includes a duty of care that requires directors to make decisions with due deliberation, a duty of loyalty that addresses conflicts of interest whereby the interest of shareholders should prevail over the interest of a director, and a duty of candor that requires that management and the board inform shareholders of all information that is important in their evaluation of the company and its management. These fiduciary duties are often translated in the legal requirement of having at least two or three professionally run subcommittees at the board: (1) a committee of internal audit and internal control to contain accounting and other specific risks, (2) a nomination committee that explicitly safeguards that the best professional CEO will be chosen, and (3) a remuneration committee

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that decides on an appropriate and fair remuneration package for its top managers, and sometimes (4) a subcommittee to assess the risks that are allied to the suggested strategy. Governance systems are influenced by the owners of the firm, its managers, creditors, labor unions, customers, suppliers, investment analysts, the media, and regulators and all those who could significantly affect [the value of] the company. 5 And although we do not predict a complete convergence of the outsider and insider corporate governance models, we believe, indeed, that certain generic widely accepted “best” governance principles could function as some basic “rules of the game” where Indonesia could start to walk its talk to become a responsible global citizen. Codes of good governance present a comprehensive set of norms on the role and composition of the board, relationships with shareholders and top management, auditing and information disclosure, and the selection, remuneration, and dismissal of executive directors and top managers. In a certain way, these suggested codes of good governance or “best practices” serve as a signal of the quality of the enterprise and may give some legitimization to these firms because of the additional information made available to shareholders and interested potential investors and relevant stakeholders. Moreover, these codes of good governance somehow force firms to comply with, if not the spirit, at least the letter of the code, and may improve the protection of [minority] shareholders. Indeed, possible regulatory interventions should remain focused on enforcing the governance principles of (1) transparency that requires timely disclosure of adequate information on corporate financial performance, (2) fairness which protects all shareholder rights and ensures that contracts are effectively enforced and integrity that guarantees some level of corporate citizenship, (3) accountability in which governance roles and responsibility of the dual boards are clarified while supporting voluntary efforts by companies to ensure the alignment of managerial and shareholder interests, as monitored by the board, and finally (4) responsibilities that ensure corporate compliance with laws and regulations that reflect the society’s values and the broad sensitivity to the objectives of the society in which corporations operate. That implies that organizations operational in sensitive industries such as mining and agri-business cannot further ignore the credible and important demands for more environmental and social sustainability. 6 The very influential paper by Morck, Shleifer & Vishny (1988) found a “see-saw shaped” relationship between ownership and firm value. The authors empirically suggest that at low levels of managerial ownership, less than 5%, equity ownership and firm value are positively correlated which is consistent with the assumption that management ownership through equity and options provides positive incentives to improve firm performance. However, at higher ownership levels, between 5 and 25%, the relationship turns negative means could be explained by the fact that at those medium level of the graph, higher ownership by management seems to decrease the value of the firm. That could be explained by the hypothesis that relative large ownership positions, but not majority, allows management entrenchment and weakened oversight. In other words, management is able to gain some control over the firm and use its position of influence to extract personal wealth, often at the cost of other shareholders who bear those costs. However, at much higher ownership levels (above 25%), the relationship turns positive again which could mean that when managers own such large portion of company equity, they bear a large share of the cost of their own actions, which discourage personal rent extraction and reinforces incentives to enhance firm value. There is thus evidence of both positive (lower than 5% or larger than 25%) and negative effects (between 5 and 25%) of managerial ownership. This empirical evidence provided by Morck et al (1988) confirms the importance of the agency problem that partially can be neutralized by granting equity to management and by having a good functioning board (within an outsider governance system) monitoring and controlling top management. However, other recent research by Larcker et al (2011) is less adamant about the relationship between ownership and value creation; that relationship now seems to be much more fragile than suggested in earlier research. Nonetheless, it seems plausible that managerial incentives are higher when top management and possibly insider-board members as well have some reasonable level of “equity skin in the game”, despite the recent lack of strong empirical evidence, mainly caused by the difficulty to untangle the causal direction of the relation between ownership and performance: do equity incentives cause better performance, or do firms that expect an improvement in future performance increase equity grants to executives in anticipation of this improvement (Larcker et al 2011: 291)? The idea behind granting equity ownership by top management in an Anglo-Saxon framework is intended to provide incentives that motivate managers to improve corporate performance, but it also has the potential to encourage undesirable behaviors as (1) manipulating accounting results to inflate stock price or achieve bonus targets, (2) manipulating the timing of option grants to increase their intrinsic value (though forbidden under Sarbanes-Oxley Act), (3) manipulating the release of information to the public to correspond with more favorable grant dates, and (4) using

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inside information to gain an advantage in selling or otherwise hedging equity holdings. If that happens, granting equity to top management encourage agency costs instead of the intended reduction and discouragement of such costs. Considering an Asian context, the following hypothesis could be put forward: families owning more than 50% of the equity of a company will have incentives to increase the firm’s performance, especially over a longer period taking into account some specific cultural aspects, so characteristic for Indonesian Chinese family businesses. However, that hypothesis does not contradict the fact that the same family owners may still extract some benefits or assets from the firm at the expense of minority shareholders. Such rent seeking by main stockholders is typical for an insider governance system. 7 My colleague Prof. Dr. Ir. Nigel Roome at the Vlerick Leuven Gent Management School urges companies to completely re-think their business models and their CSR activities which in his opinion are often misperceived and misguided. Mere PR exercises in the form of CSR will not be effective or sustainable. I share his convincing argument that sustainability needs to be re-defined and “built-into” the way business is conducted. 8 See Verhezen, 2009 based on an epistemic analysis of moral notions by Bernard Williams and Hilary Putnam. The notion of truthfulness or Wahrhaftigkeit has an objective status – as well as a normative one. The epistemic criteria of moral worth remain fallible and dependent on (1) our intentional sincerity and (2) professional accuracy of using our moral vocabulary. Indeed, truthful moral reasoning requires the “virtues” of (1) sincerity (“what you say reveals what you believe”) – or trustworthiness – and (2) what Bernard Williams refers as accuracy (“you do your utmost best to acquire true beliefs”) – or ‘objectivity’ acquiring abilities (2002). While sincerity is no proof against error, it is just the disposition so say what you think is true without wanting to mislead, but intentionally looking towards the truth of the matter. Sincerity involves a certain kind of spontaneity when one tries to ‘tell the truth’; it refers to a normative pragmatics or a matter of deontic attitude centered on the notions of commitment and entitlement. Being sincere implies a self-reflective attitude of authenticity. One is authentic when on is true to oneself. Authenticity requires having the will you want to have – identifying by what you care about with the ‘desires’ [of integrity] that guide your action. The notion of accuracy includes resistance to self-deception and wishful thinking, which implies the acknowledgment of traditions and (scientific) authority. Accuracy implicitly refers to [a semantics explaining] a conceptual content or relevant semantic adequacy. 9 See Verhezen, 2009 & 2010. Sustainable value implies that the firm is able to supply great and sustainable products and services, will create trust and social capital. A board who is accountable will comply with the rules and regulations and norms – as in the Aristotelian tradition of hoi nómoi - of the place where the firm is operational. Corporate responsibility is linked to the arête or virtue of corporate leadership that usually depends on a moral choice and discourse that seeks consensus – the Aristotelian bouleusis. Somehow corporate leadership will be able to resolve corporate challenges by practical managerial knowledge – as in phronesis – and managerial wisdom, that is underpinned by virtuous behavior and compliance with rules and law – that according to Aristotle should be derived from a discourse (logos) and from practical understanding and intuitive insight (nous). 10 See McKenna et al , 2009; Schwartz, 2011; Hayes, 2004. Wisdom can also be constructed as a metatheoretical (or apriori) construct that can function as a benchmark or apriori ideal (McKenna et al 2009). How to understand such practical wisdom? An Aristotelian interpretation of integrity as aretè – as the author here suggests - is not just a self-contained trait of virtuous character, but rather an interactive attitude in relationship with others that increases self-understanding and awareness of one’s ideals and objectives as well as the threats to those. Boards and corporate leadership should get engaged in building organizations that serve its constituting shareholders, employees, customers and other important constituencies in reciprocal and “spirited” exchanges. When corporate leaders would underwrite the principle of a larger “common” purpose for their organizations (Kanter, 2009 & 2011), only then “wisdom” - as an unfolding nonlinear journey of trial and error processes of truth seeking in action or praxis [to do the right thing, and to do the things right] - may become relevant both for the organization and society. However, if management is stuck to the current market system model, philosophical and spiritual wisdom will unfortunately remain completely irrelevant for most organizations, and its society at large. What might be the driving factor to make managerial wisdom relevant for organizations? In other words, how to enhance the potential of some practical wisdom or phrónèsis into management practices and management research? Being wise is a social practice; it is also part of a discursive structure. Managerial wisdom is an ability that enables us to minimize our cognitive limitations of our bounded rational capabilities by relying on an intuitive process based on values (as in integrity) and experience (i.e. practice) through continuous learning and be open to new innovative potentially transcending ideas. Wisdom is a way of being and is fundamentally practical in

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a complex and uncertain world. An Aristotelian interpretation emphasizes the necessary virtues of corporate leadership (Solomon 1993) in addition to the need for appropriate and just rules and incentives. Some authors would even argue that rules and incentives actually erode managerial wisdom because they demoralize activities and the people who engage in them (Schwartz, 2011). Moreover, real managerial wisdom is not a tick-the-box-compliance exercise or an ideology, but a continuous search by trial and error to improve leadership that seeks operational effectiveness to produce great products and services at competitive prices. Wisdom is here defined as the praxis to act rightly, depending on our ability to perceive the situation accurately, to have the appropriate feelings or desires about such a situation, to discern and reflect about what is appropriate in this particular situational context, and to act upon it (Schwartz, 2011; Hayes, 2004). Moreover, such wisdom is fueled by a continuous learning process that acts, re-acts and pro-acts in particular situations, based on the experience gained, the knowledge acquired in the process and the integrity needed to guide it. Hence why McKenna, Rooney and Boal (2009) - and other authors - ascertain that knowledge without integrity can be dangerous and dreadful while integrity without knowledge is rather weak and not focused. Moreover, knowledge here gives priority to the particular, as in a real Aristotelian tradition, while respect and reflection are the crucial feeders for learning that likely reflects an elucidation of how practical wisdom may unfold.

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About the author

Peter Verhezen is currently an Adjunct Professor Strategy and Risk Management at the Vlerick Leuven Gent Management School (Belgium), and a Visiting Associate Professor & Principal Fellow for Global Corporate Governance at the Management Graduate School of the University of Melbourne (Australia). He is also a fellow for research in Governance and Asian Studies at the Ash Institute of the Harvard Kennedy School (USA). Prior to these academic appointments, he has been a management consultant and entrepreneur for more than 25 years, mainly in Asia. As the current Principal of Verhezen & Associates Ltd, he advises organizations on Integrated Risk, Strategy and Governance in SE Asia and Australia. He obtained a Master’s in Applied Economics (International Relations) from Antwerp University (Belgium), an MBA (Finance) from Leuven Vlerick Business School/Chicago Business School and a Master’s and PhD in Philosophy from the University of Leuven (Belgium). His current interests are governance, sustainable value creation, emerging markets. 11

Our moral decisions and actions are justified by an overlapping consensus, guided by

epistemic criteria [or “virtues of truth”] of sincerity and accuracy11 (Verhezen, 2009; Williams, 1996 & 2002; Stout, 1993 & 2003; Grayling, 2007). We have only practical wisdom to justify our beliefs and to live a truthful life as sincere and accurate as possible beyond the dominance of cognitive aspects of our life (Verhezen, 2009). Effective leaderships knows how to embrace managerial wisdom to enhance the overall performance of the firm.

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