Corporate Governance Life Cycle

2. Corporate Governance Life Cycle Igor Filatochev, Mike Wright Strategic Entrepreneurship

3. 2 objectives of Corporate Governance • Ensure accountability of management in order to minimize downside risks to shareholders • Enable management to exercise enterprise in order to enable shareholders to benefit from upside potential of firms

4. Competitive advantages • Effective governance systems may have a positive effect on enterprise’s resources management • By monitoring and incentivizing managers to undertake relevant actions • Managers may be able to appropriate a disproportionate share of rents generated by the firm

5. Stages of governance • Governance issues arise as firm approaches the so-called entrepreneurial crisis stage (constraints to realize growth opportunities) • Founders-managers have to cede control for letting the company grow • Firms’ organizational learning has to develop in order to cope with a more complex environment

6. Governance life cycles • Governance systems have to change in accord to the firm’s evolution • Firm’s evolution is reflected by changes in ownership structure, board composition, degree of founder involvement, etc • Governance focus on accountability or incentivizing management change in establishment, growth, maturity and decline

7. Organizational and corporate governance dynamics Narrow Resource base Organizational Extensive

8. Governance life cycles • As firm matures, changes in structure shift the balance to monitoring and control function of governance systems • In maturity and decline resources and strategy role of governance become important • Top management and outside investors have to find the right balance between multiple functions of governance in evolving firms

9. Governance and VC • Firm strategy and governance life cycles should be analyzed together with economic and institutional dynamics of the country • Venture capital (VC) have strong influence on governance development through firm growing stages • Investors base widens from personal business angels to VC to stock market

10. Governance and VC • Firm’s control moves from entrepreneur to outside investors to financial institutions (with VC as screen) to stock markets • VC helps to bridge a transition • Notion of VC may vary in different institutional environments • VC has a unique role in UK and USA, in some countries VC is just a screen for banks investing in high risk firms

11. Growth and complexity • As environmental and organizational complexity grow, different skills are needed • Founders knowledge may create cognitive barriers (threshold enterprises) • To solve this problem firms must cede control to professional managers • Board composition varies from start-up (1-5) to adolescent years (6-8) influencing innovation and financial performance

12. IPO and Venture Capital • IPO is the first major shift in firms’ life cycles • Emergent investors demand accountability in exchange for their support • Venture capital backed IPO suffers of two sets of conflicts, between funders and managers an between founders and members of VC syndicate • New forms of governance may help in managing these conflicts

13. VC Syndicates • When risk is high, VC syndicates (more VCs) invest in firms • VC syndicate-backed IPOs have more independent board than single VC backed ones and than non VC-backed ones • Lock–in arrangements: pre IPO shareholders refrained from selling firm shares after IPO • Lock-in arrangements solve problems not solved by traditional governance arrangements

14. Lock-in arrangements • Examples of governance issues solved by lock-in arrangements are information asymmetry in fast growing firms and need to retain key managerial talent • Often firm’s post IPO performances are poor, possible causes are total risk, growth rate of assets, less involvement of founders, existence of non voting shares

15. Governance in Mature Firms • Conventional size-based remunerations of executives leads to corporate empires • Share-based compensation was introduced to incentivize executives to divest non-core activities • Options are a cost effective form incentive in order to persuade manager to divest

16. Governance in Mature Firms • Retrenchments i.e. sales of critical assets is a form of turnaround management adopted in mature companies • May hamper firm’s long term profitability • Is more successful in multi product firms where resources may be switched from one sector to another • Management must avoid committing to high fixed-cost sunk investments

17. Governance in Mature Firms • For mature companies it is harder to adapt governance systems to changing environment • An example may be failing to exit from a declining sector • Taking a public company private (delisting) leads to cut agency costs and increasing incentives for managers

18. Governance in Mature Firms • Going private means increase equity owned by manager • Private equity firms are more active investors (board positions) • More pressure on manager to issue effective reports and service company's debt • Stronger governance than in public companies

19. Independent Board Members • Independent boards are more effective in monitoring firm management • Private equity firms are more active investors (they hold board positions) • In a firm going private incentive effects are stronger than monitoring effects