Loosey-Goosey Governance: Four Misunderstood Terms in Corporate Governance

Bottom Line: The debate on corporate governance today suffers from "loosey-goosey" terminology, preventing a clear understanding of what makes a governance system effective. Critics have a tendency to overgeneralize and a tendency to use central concepts without clear and accepted definitions. Consensus solutions on corporate governance issues could occur if terms were more well-defined.

Corporate governance analysis suffers from 1) the tendency to overgeneralize across companies—to advocate common solutions without regard to size, industry, or geography, and without understanding how situational differences influence correct choices; and 2) the tendency to refer to central concepts or terminology without first defining their concepts, premises, evidence, or implications.

The study identifies several examples of this "loosey-goosey" terminology plaguing governance analysis:

1. Good governance -- Many of the structural features commonly associated with good governance (such as board structure, share structure, etc.) are not shown to have a consistent relation with performance, and many of the organizational features that might lead to superior performance (such as leadership quality, board oversight, culture, and incentives) are not well studied or understood.
2. The role of the board of directors -- A gap exists between what outsiders think a board does and what they actually do. Furthermore, outside observers, including shareholders, have very limited insight into the factors that would help them understand the quality of oversight that their board provides.
3. Pay for performance -- A third concept that is not well understood is pay for performance. Dissatisfaction with CEO compensation is widespread.  The term “pay for performance” denotes the idea that the amount paid in compensation should be commensurate with the value delivered. Several factors make it difficult to evaluate pay for performance.
4. Sustainability -- Critics contend that companies today are too short-term oriented and are not making sufficient investment in important stakeholder groups (such as employees, customers, suppliers, or the general public) because they are overly focused on short-term profit maximization. However, it is not clear that companies today are unsustainable nor is it clear that senior executives are mostly short-term focused or overlook stakeholder interests as they develop their strategy and investment plans.

The study posits four related governance questions that still can't be answered thanks to the loosey-goosey terminology:

1. After decades of research, why can we still not answer the question, “What makes good governance?”
2. How can the understanding of board quality improve without betraying the confidential information that a board discusses?
3. Why is it so difficult to answer the basic question, “How much should the CEO be paid?”
4. Are companies really short-term myopic?

To adequately answer these governance questions, analysts must use and demand more precise terminology.

Read the full paper here.