Corporate governance and informational asymmetry

That extant realities of globalisation implicate political turbulence, socio-economic, environmental, technological complexities and volatilities is no longer news. No one State is immune to these strategic uncertainties. Those uncertainties traverse moral and military support to either of the warring parties in the Russo-Ukrainian conflict. They include climate change and its continuing aftershocks like warmer climes, de-forestation, desertification in sub-Saharan-Africa, ditto, relative complexities on accomplishing net zero targets by some nations; the intended and unintended consequences of artificial intelligence; the global economic contraction, or weak corporate governance – a whole gamut of issues all of which demand answers and solutions.

Governments, multilateral organisations, non-governmental organisations and corporates intermediate within those spaces consistent with their raison d’être, however, answers and solutions are neither easy nor quick! The focus of this paper is informational asymmetry within the corporate governance perspective and arising agency problems.

Broadly, the essence of corporate governance is inherent within its inversion: the governance of a corporation. It seeks to address fundamental questions pertaining to the strategic leadership of corporations, how effectively and efficiently it is run by the executive, non-executive directors and corporate management.

In its purist characterisation, corporate governance, aims to assess, and address, the fit with the organisational vision, mission, objectives and values (corporate strategy) which, ideally, should meet a dectet of constants: i.) compliance with relevant laws, regulations and best practice; ii.) optimally delivering shareholder value; iii.) adaptability and responsiveness to changing market and socio-economic/political dynamics; iv.) advantageously exploiting technological innovations; v.) effectively developing and utilising competent human resources; vi.) evaluating performance and trends; vii.) embedding effective risk management processes; viii.) driving innovation in operational processes, product development and service offerings; ix.) demonstrably consistent ethical practices in corporate strategy, values and culture; and, x.) integrating and normalizing fit-for-purpose environmental sustainability strategies.

More formally, according to the Organisation for Economic Cooperation and Development (2015, p.9), corporate governance involves a set of relationships between a company’s management, its board, its shareholders and other stakeholders. It also provides the structure through which the objectives of the company are set, and the means of attaining those objectives and performance monitoring are determined. Likewise, the Nigerian Code of Governance 2018, an output of the Financial Reporting Council, aims to reinforce global best practice in corporate governance in firms across the country. Section 2, for instance, proffers a flexible amalgam of executive directors, non-executive directors and independent non-executive directors reflecting a prime balance of expertise and skillsets. Section 3, frames the premise for the segregation of duties between the Board chairman who provides strategic leadership and direction and executive directors who drive day to day operations. And, it advances more effective interoperability between the Chairman and non-executive directors. The reasoning is sound.

Indeed, these are all are fine standards, the proper application of which, underpin the effectiveness and sustainability of some of the world’s most successful companies and organisations. And the converse is the case too, with those corporations that have either wittingly or unwittingly, ditched the fundamentals of corporate governance, and were once considered to be “too big to fail.” Some of the latter include Bear Sterns, Enron, Lehman Brothers, Madoff Investment Securities, Northern Rock, Nortel. And more recently, in 2023, Silicon Valley Bank, Signature Bank and First Republic Bank.

So many questions are prompted by the collapse of these major institutions. Why, after all the advances in statutory and regulatory provisions, do corporations still fail? Are regulatory frameworks honoured more in breach than observance? Could it be a failure of strategy, or the ineffective application thereof? Is it a case of irresponsible risk taking and therefore sub-optimal corporate risk management processes? A failure of leadership perhaps?

Unbundling these posers, it is clear that statutes, regulations and enforcement actions are not, in themselves, inexorable deterrents to unethical practices and or irresponsible risk-taking by corporations. For example, the United States Congress passed the Sarbanes-Oxley Act 2002, to mitigate the risk of corporate malpractices, mandating the completeness of financial record keeping and reporting. Furthermore, it imposed a positive obligation on senior management to individually certify the accuracy of financial information whilst imposing stiff penalties for fraudulent financial acts; as well as widening oversight directors’ oversight responsibilities, ditto external auditors’ independence. Another seminal Congressional enactment is the Dodd-Frank Wall Street Reform and Consumer Protection Act 2010. It aims to reinforce the financial stability of the United States by improving accountability and transparency in the financial system by protecting taxpayers and consumers from abusive financial services practices et al.

Contextually, Silicon Valley Bank, was shut down by the California Department of Financial Protection and Innovation in March 2023 because its investments decreased in value, following which there was a run on the bank with depositors exiting substantial capital. The Federal Reserve Bank’s findings robustly asserted, inter alia, that “Silicon Valley Bank’s board of directors and management failed to manage their risks”. The Reserve also attributed blame to its own supervisors who “did not fully appreciate the extent of the vulnerabilities as Silicon Valley Bank (SVB) grew in size and complexity…when supervisors did identify vulnerabilities, they did not take sufficient steps to ensure that SVB fixed those problems quickly enough”

Consumers, driven by fears of losing their deposits in the aftermath of the SVB saga, then began withdrawing huge sums from the Signature Bank and First Republic Bank in March and May 2023, respectively. That prompted the Federal Deposit Insurance Corporation, enacted pursuant to the Banking Act 1933, to place both institutions in receivership, crucially, helping to safeguard depositors’ funds.

Beyond that however, is there such a thing an entirely risk-free enterprise in a capitalist economic system? That is, risk capital, which is defined here as shareholders’ investment outlay in a business enterprise, has a binary outcome: it is either profitable or unprofitable, over the short, medium or long-term. To the extent that a business venture, is by definition, an informed business hypothesis, that a commercial proposal will, with the right strategy, combination of human, financial and physical resources deliver commercially-viable products and offerings; is itself a risk, arguably, there is no such thing as a risk-free enterprise. The real question, therefore, is how much risk should an enterprise absorb and how best should those risks be mitigated?

It is in that vein that the economic and legal concept of informational asymmetry emanates within the corporate governance realm. Informational asymmetry entails the inchoateness, incompleteness and inexactness of information, data, strategic awareness between parties which, often gives rise to agency problems in corporate governance thematics. That is simply because one party has better information than the other. Within a corporation, the directors, non-directors and corporate management are “agents” of the “principals” (the shareholders and owners). Because of their strategic and operational management responsibilities, expertise and skillsets, relative proximity to market, regulators and stakeholders, invariably, agents tend to possess the informational advantage, which means the asymmetric advantage weighs in their favour.

The principals, in this context, delegate strategic and operational management of the firm to the agents in the legitimate expectation of a return on investment, optimisation of shareholder value, transparency, ethical practices, viable corporate strategies and implementation thereof, regulatory compliance and effective risk management. Patently, some agents, engage in the very opposite, either through negligence, recklessness or, with intentionality. The net results of negligence by agents, is a financial and reputational cost on the corporation, which invariably means the principals, that is, the owners and shareholders.

For example, company X, engaged in top-end crypto-software security. X, pursuant to a closed competitive procurement exercise, wins a defence contract to supply software units across all portable devices in military formation Y, worth USD millions. However, months into its deployment, X’s software is found to be insufficiently robust, thereby susceptible to sustained external malware attacks. The contract is cancelled, X is successfully sued for the tort of negligence and ordered to pay specific and general damages in the USD millions.

Aside from the financial cost to the business, and by extension, the principals (owners/shareholders), the reputational damage is incalculable. In that scenario, X may or never recover as a viable business.

Closing, the dectet of corporate governance constants, supra, are not one-off processes. Rather, they are interdependent and iterative principles upon which the effectiveness, and sustainability of viable organisations thrive. Accordingly, it is recommended that aspirational corporations consistently reinforce these kernels as well as the underpinning ideology of corporate governance viz:1) developing an enduringly effective organisational strategy; 2) embedding accountability; 3.) demonstrable transparency; 4.) equity, fairness and high ethics; 5.) taking ownership and responsibility; 6.) independent assurance; 7.) ensuring security of resources and assets; 8.) sustainable stakeholder engagement; 9.) transformational leadership; and 10.) adaptability to changing environments.

Little wonder, Mervyn King, ex Bank of England Governor’s summation strikes the right chords:“global market forces will sort out those companies that do not have good corporate governance”.
Ojumu is the Principal Partner at Balliol Myers LP, a firm of legal practitioners and strategy consultants in Lagos, Nigeria.