The scandals at Enron, WorldCom, Adelphia and other
corporations have focused public attention on how companies can
crash and burn when corporate governance goes wrong—but what
about when corporate governance goes right? What role can good corporate
governance play in helping successful companies to create a sustainable
competitive advantage?
Stock analysts and financial advisors love companies with wide “economic
moats.” Basically, these are companies with some kind of sustainable
competitive advantage that keeps other similar businesses from encroaching
on their profits.
Take Wal-Mart, for example. Its competitive advantage is that it
is a low-cost producer in its industry, charging as much as 15 percent
less for food products that traditional grocers. How about eBay?
As one of the few online auction sites, its competitive advantage
is known as the “network effect.” Buyers go there to
find the sellers, and sellers go there to find the buyers. Where
else would they be?
Extensive research exists about how companies benefit from an array
of competitive advantages, but there’s not as much on how
competitive advantages are created in the first place. That basic
question has motivated Richard Makadok’s research for the
past five years. Makadok, associate professor of organization and
management in the Goizueta Business School, has written a series
of papers about the creation and use of competitive advantages by
companies.
In a paper forthcoming in a special issue of Strategic Management
Journal, Makadok holds that corporate managers should be governed
to serve the best interests of shareholders, and not their own.
“A lot of research has been done on manager capabilities and
competence on the one hand, and a whole other body of research has
been done on corporate governance, but very little at the intersection
of those two,” Makadok said. “There is very little that
looks at how competence and governance interact. That’s a
big piece of the contribution of this paper. For the first time,
we now have a reason to believe there should be a positive, synergistic
interaction between the two.”
Wal-Mart, Makadok said, is a prime example: a top-performing company
bursting with competitive advantage that historically stands out
for both its competence and its governance. It has managed to generate
a 200,000 percent return to shareholders in the 30 years since its
initial public offering through amazing distribution efficiencies
(competence) and outstanding opportunities for employee stock ownership
and profit-sharing (governance). Makadok suggests that the extraordinary
performance at Wal-Mart and other companies, like Microsoft, is
“due to a synergy between governance and competence.”
He develops this hypothesis by analyzing certain scenarios that
incorporate both competence and governance, and how they impact
managers’ resource-investment decisions, otherwise known as
the potential competitive advantage. Makadok writes that managers
of firms with agency problems (basically having a CEO, or agent,
whose interests differ from those of the shareholders), will on
average tend to under-invest (below what shareholders would hope)
in resources of uncertain value.
“This underinvestment will be most severe for those resources
where managers’ information indicates a low expected value
[a risky investment],” Makadok said, “and will actually
be reversed [overinvestment will occur] for those resources where
managers’ information indicates a high expected value [a safe
bet].”
Two so-called levers can be used to reduce the degree of underinvestment:
reducing the severity of the agency problems through better corporate
governance, or improving the accuracy of managers’ expectations.
These two levers, Makadok said, are more effective together than
in isolation.
“There’s a synergy, if you will, between governance
and competence—between having competent managers who know
the right resources to acquire and having a system that governs
those managers in a way that will use that knowledge for shareholders’
benefit, rather than their own benefit. The end result will be creation
of a competitive advantage,” Makadok said. “Having managers
who are motivated to do the right thing for shareholders is not
much help if those managers don’t know what the right thing
to do is. Conversely, having managers who know the right thing to
do for shareholders is not much help if those managers aren’t
motivated to do it.”
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