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Corporate governance and innovation performance: Policy implications

One of the arguments of this project is that policy towards corporate governance is a key factor governing innovation and economic growth performance and deserves greater attention from policy-makers. One of the conclusions likely to emerge from this project is that there should be a more significant European level in shaping corporate governance systems and in deciding their content. Specific policy implications from the project are discussed above, in the fourth paper of this project. More generally, the policy implications are as follows.

‘Corporate governance’ refers to the systems of law, regulation, and accountability that provide the institutional framework within which corporations are managed and controlled.

Corporate governance is normally seen in terms of the problem of making managers responsive to shareholder interests. This project seeks to place the general issue of corporate governance into the much wider framework of economic development and growth. In the conventional framework, corporate governance is seen in terms of how to secure the interest of owners when corporations are in effect directed by professional managers; this is approached in terms of principal-agent problems, in which the market for corporate control secures the ultimate interests of owners and in which freely functioning equity markets - which place strong short-run profit objectives on managers - are a central economic mechanism and policy instrument. This project sees the problem in terms of innovation: how do corporate managers secure the powers and authority to organize firms and commit resources to learning (that is to make long-term intangible investments), and thus generate innovation-based growth? What are the long-run effects of different solutions to this question, and what are the policy implications?

The approach of the project is to offer a comparative-historical analysis of economic development and international competition in the large advanced economies, in particular making a triadic comparison of Europe (meaning the United Kingdom and Germany in this case), the United States, and Japan. Against this background, it suggests two fundamental conditions that characterise the social organisation of innovation. One fundamental characteristic, which in the project is called organisational integration, is that the people involved in the process of organisational learning be willing and able to make their skills available and efforts to the pursuit of organisational goals. The other fundamental condition, which in the project is called financial commitment, is that the business enterprise has sufficient access to financial resources to sustain both the innovation process until it can generate returns and the business organisation so that it can engage in continuous innovation.

The project argues that the different systems for meeting these conditions have very different long-term outcomes and play a large part in explaining different development trajectories for the countries concerned. The project suggests that this type of approach opens up the possibility for market-oriented policies that affect innovation capabilities and performance without direct intervention. However there remain strong differences between countries in terms of these systems at the present time, and harmonisation of corporate governance rules is already an issue in the EU. The main policy recommendation of this project will be that such harmonisation, which is both inevitable and desirable, should occur on the basis of conceptions of corporate governance which are founded on real, long-run innovation performance and not on the maximisation of short-run returns to stockholders.

Many aspects of public policy-including especially the operation of stock markets and their impacts on mergers and acquisitions activity-over the past decade have in effect been aimed at changing systems of corporate governance. These changes, however, have not taken the organisational and innovation capabilities of companies into account. Policy-makers have not considered how policy measures aimed at improving efficiency (that is, market efficiency) might affect long-term asset building. This is a pressing problem because long-term asset accumulation is essential to develop organisational and innovation capability.

From an innovation perspective, the basic criticism of the ‘Anglo-American model’ of corporate governance is that it inhibits the creation of the intangible assets needed for good innovation performance. It forces managements into maximising short-term rates of return. In particular, managers do not have incentives for investing in workforce skills, R&D resources, design and engineering development and so on. These might be important in the long run, but in the short run they are current costs, which reduce current profitability. The German and Japanese systems have placed more emphasis on growth, on human capital development and on acquiring market share-short-term profitability has been seen as less important than long-term viability. The German and Japanese systems have been more focused on creating value; the Anglo- American system is more focused on extracting value from the firm. The choice between these types of corporate governance system will be a key issue for Europe in the future.


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Evaluation - Policies