Strong Governance Actually Makes Weak Companies

I’ve spent a lot of time in recent years thinking about governance: its role in the current state of the markets and society, the way it functions in individual companies and also as a powerful collective force, and how we can approach it in a less monolithic way when we sit down to structure companies from the ground up.

Over and over, I’ve seen founders succumb to the idea that their governance has to be the same as everyone else’s in order to succeed – or even to get their company off the ground. Just as many times, I’ve seen them regret making that decision at some point down the road for any number of reasons.

I was intrigued to read about this study on the effects of what we traditionally think of as “good” governance in a recent Bloomberg column by Matt Levine. It makes the argument that so-called strong governance, which prioritizes shareholders, is actually bad for companies and bad for competition. By comparing what the authors call “separate” versus “common” (ie, institutional) ownership, it looks at the ways in which “common owners indirectly, and perhaps unintentionally, exert market power by delegating control rights to other shareholders through the broad implementation of “strong” governance structures across their portfolio firms.” 

It goes on, highlighting the scourge of activist investors: “These delegated control rights are then leveraged by non-diversified investors, such as activist hedge funds, which pressure managers of their target firms to reduce investments. The aggregate effect of lower investments reduces the demand for labor and wages. Importantly, even though activist hedge funds do not internalize externalities across firms, the cumulative impact of their interventions contributes to anti-competitive outcomes, manifesting as a monopsony in the labor market.”

They have plenty of data to show that the rise of common ownership over the last thirty years has broken the “feedback loop between wages and governance,” thereby disturbing the cycle of losing and regaining equilibrium that is a hallmark of a truly competitive environment.

Of course, this kind of activist behavior is not only bad for investment and competition. It’s also one of the main mechanisms for gutting companies entirely, often even ousting the very founders who had no idea they were planting the seeds of their own demise in the early days (see above: governance set-up regrets). 

There are many better ways to create governance structures than what’s currently deemed acceptable by the lawyers who seem to crank out the same charter for every single company. All it takes to do it is the willingness to take a leap of faith for the long-term sake and health of the organization. A tall order right now, perhaps, but one that I hope will become the normal way of doing business.