Corp Gov and Stakeholder Theory

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S TAKEHOLDER THEORY AND CORPORATE GOVERNANCE:

THE R OLE OF I NTANGIBLE AS S E T S 1

Abstract (extended)

Since the beginning of the 21th century, a few serious financial scandals and many cases of

corporate mismanagement have driven scholars and politicians to devote increasing attention to

corporate governance, in a close relation with business ethics issues. In academic literature, as

well as in public policy debates, corporate governance is nowadays acknowledged as a critical

factor in economic development and financial markets stability.

Actually, the recent phenomena represent the peak of a long-lasting widespread crisis of

corporate governance. In the last decades, we observed a general disbelieving for those forms of

corporate organization that played a fundamental role in the economic development of the

leading industrialized countries: the public company in the US and in the UK, the bank or state-

owned corporations in continental Europe, the keiretsu in Japan. In the Anglo-Saxon countries,

public companies management, in order to comply with short sighted and diversified investors,

tends to focus on short-term earnings, disregarding those long-term investments badly needed to

enhance firm performance vis--vis competitors rooted in different systems. On the other side,

economic systems based on closely held companies and financial intermediaries as primary

financing source, are increasingly failing in providing an adequate equity base to finance

successful competitive strategies in global industries.

In both cases, the evolution in the nature of the firm is among the major causes for the crisis of

established corporate governance models. The traditional manufacturing companies - vertically

integrated and capital intensive which emerged at the beginning of the last century and had

since then prevailed have been challenged by new organizational structures, based on

intangible assets and networks, more appropriate to a dynamically changing environment, where

competition is driven by the availability of distinctive competencies, based on firm-specific

knowledge.

1

Arturo Capasso Universit degli Studi del Sannio Tel. +39-0824-305766 Fax +39-0824305777email: [email protected].


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Arturo Capasso - Stakeholders Theory and Corporate Governance

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This paper, building on the resource based view of the firm, but also on stakeholder approach to

strategic management, explores how the growing importance of intangible assets is reshaping, in

many industries, the basic conditions of corporate governance. The aim is twofold: i) to explain

logically why intangible assets modifies the allocation of residual claims, as company

performance can substantially affect the wealth of other stakeholders ii) to determine which

constituencies should be considered as relevant stakeholders and contribute, to some extent, to

the corporate governance.

Company law says that shareholders own the assets and the free cash flows, but this only works

on the basis of a primitive view of the nature of ownership and employment. The crucial

intangible assets could be, in many cases, out of the direct control of either shareholders or

management. They are, in fact, shared in common between the firm and some of its stakeholders,

like employees, customers, suppliers. In order to build and enhance its intangible endowment a

firm has to establish and consolidate a trustworthy fiduciary relationship between the firm and

these stakeholders. The costs to establish and consolidate these relationships can be considered

as subordinated claims on firms cash flow to remunerate the stakeholders for the irreversible

investments and commitments that are the main drivers of intangibles assets. Therefore,

stakeholder can be considered as virtual shareholders, participating to an extensive definition of

equity value that could be defined stakeholder equity or systemic value. In this perspective,

stakeholder theory can be extended in order to set the acknowledgment of relevant stakeholder

claims within the framework of value maximization, although the value to maximize is not that

pertaining only to shareholders but the value of the business system as a whole.

With no ambition to give a formally rigorous contribution to the lively debate on the relation

between business and ethics, the proposed model might enable to overcome those approaches

regarding ethics either as an additional constraint for company decision making or, at most, as a

sort of generic investment in establishing a nice-company image, to be valued in terms of

expected returns.


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S TAKEHOLDER THEORY AND CORPORATE GOVERNANCE:

THE R OLE OF I NTANGIBLE AS S E T S

Introduction

Since the beginning of the 21st century, corporate scandals and mismanagement cases have driven

academic scholars to devote increasing attention to corporate governance, which is now acknowledged

as a critical factor in economic development and financial markets stability1. This phenomenon is the

emerging peak of a longstanding widespread crisis of traditional corporate governance models. In the

last decades, as a matter of fact, we observed a general disbelieving for those corporate governance

systems that played a fundamental role in the economic development of the leading industrialized

countries: the public company in the US and in the UK, the bank or state-owned corporations in

continental Europe, the keiretsu in Japan.

The hypothesis discussed in this paper is that the crisis of traditional corporate structures, in the main

industrialized countries, together with either local or contingent reasons, may have its common root in

the growing relevance that intangible assets in the composition of firm's assets.Even if the relevance of intangibles is no actual news, as firm success has always been due to its

distinctive business idea, there are some innovative aspects it is worth stressing:

i) due to progressive fading of the residual barriers, competition is more intense in many industries,

consequently the creation of competitive advantage depends on the availability of firm specific

assets,

ii) as a consequence of innovation in company and inter-company organization (lean organization, total

quality, networks, industrial districts) relevant knowledge is no longer under the direct control either

of the entrepreneurs or top management, as it is also spread at less prominent levels in the company

hierarchy and, outside, by customers and suppliers who become an integral part of an enhanced

business system (Jensen, 1993; Jensen and Meckling, 1992);

iii) growing international market integration and a more intense competitive dynamics remarkably rise, in

the main industries, the critical mass of intangible investments required to compete on wider and


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wider markets; therefore, in many firms the relative weight of intangible assets has reached levels by

far higher than in the past.

This paper aims to integrate the resource-based view (Barney, 1991) with the stakeholder theory

(Freeman, 1984; Donaldson and Preston, 1995), looking at the most important intangible assets as

entrenched in some of the firms stakeholders. This lens might be useful for examining the relevance that,

in several cases, stakeholders should have in corporate governance. Furthermore, it provides a

theoretical basis to investigate some noteworthy issues in the field of business ethics.

The paper is organized as follows. After a brief description of the historical development of different

corporate governance systems, in the next three sections we first discuss the role of intangible assets as

a source of sustainable advantage in the economic value creation process; we then describe the impact

of intangible assets on the corporate financial structure and the allocation of residual claims and finally

we develop the idea of systemic value of the firm as the combination of shareholders value and

stakeholders value. A section on the studys conclusive remarks and implications for future research

concludes.

1. Historical background

In the last decades of the 20th century, the economical and political collapse of central planned

economies, concluding the long-standing diatribe between public or private ownership of the production

means, has diverted the attention of management scholars, politicians and other interested observers on

the meaningful differences existing within capitalistic world, among the various capitalist models2.

The differences date back to the period when technological innovation, progress in transportation and

communications, international trade growth, brought about, in the main industries, a remarkable increase

of the firm minimum efficient size, conditioning the development of a modern industrial system to the

availability of financial resources and managerial capabilities exceeding the endowment of the original

entrepreneurs. In order to regulate the acquisition and the use of these resources, it was necessary to set

up suitable legal, organizational and financial instruments, which caused the getting over of a perfect

identity between the firm and the entrepreneur, with significant implications for corporate governance

(Berle and Means, 1932; Chandler, 1962, 1977).


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In each country, historical, economical, and political factors have got industrial development to follow

distinctive routes that have not only characterized the ownership and organizational structures of the

firms, but the evolution of the institutional and economic environment as well (Shleifer and Vishny, 1996;

Pagano and Volpin, 2000). Nonetheless, even if the peculiarities of different countries have outlived the

markets integration process, in the last decades, a widespread discontent for the traditional models of

corporate governance has emerged together with a great interest in the experiences of other countries

(Roe, 1993; Kester, 1992).

In the US, such a phenomenon fully showed during the eighties, in a long season of hostile takeovers,

leverage buyouts, proxy fights (Jarrel et al., 1988; Jensen, 1988). In Europe - with the notable

exception of the UK - the takeover-mania has undoubtedly been less pervasive, but interest in the

debate on corporate governance has livened up as a consequence of a general reconsideration of the

State intervention in the economy. Privatizations have indeed characterized the economic policies of the

leading European countries, even if outlined programs have not always been carried out, everywhere,

with comparable resoluteness and results. Furthermore, even in Germany and Japan the typical

governance models - grounded either on banks controlling interests or on intricate cross-shareholding

webs - have proved largely inadequate, seriously deteriorating the myth of the general dedication of allfirm's participants to the commonweal (Watanabe and Yamamoto, 1993; Tricker, 1994, Yafeh, 2000).

At the beginning of the 21th century, we assist to a general disbelieving of those forms of business

organization that played a fundamental role in the economic development of the leading industrialized

countries: the public company in the US and in the UK, the bank or state-owned corporations in

continental Europe, the keiretsu in Japan.

The crisis of traditional models clearly demonstrates how corporate governance is the thorny question in

the evolution of the capitalistic society: on the one hand the international integration process urges to

accelerate a series of important changes, affecting firm ownership and organizational structures, on the

other hand existing situations are so deeply rooted in the culture and institutional environment of each

country that getting over them requires a long difficult process. Therefore, the growing interest in the

topic of corporate governance is not simply academic, but gives evidence for the search of an

explanatory theory in order to develop appropriate solutions to relevant practical problems.


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2. Economic value creation and intangibles assets

In business literature there is a widespread consensus in recognizing the economic value creation as the

main objective of the firm, independently of its ownership and organizational structures. Maximizing the

economic value created by the business system as a whole - seen as the capitalization of the expected

return above that required to keep the resources involved available to the firm in the long run - is

unanimously considered a neutral goal, all main stakeholders could share. In order to create and

maximize economic value firms have to develop and safeguard rent positions cutting off competition or,

according to the strategic management terminology, a sustainable competitive advantage (Porter, 1985).

According to the resource based view (RBV) of the firm, in dynamic and efficient markets, a realistically

sustainable competitive advantage must inevitably be rooted in some unique or idiosyncratic resource

controlled by the firm (Barney, 1991). This resource should be necessarily out of the marketor, in

other terms, not autonomously negotiable. For if the source of a competitive advantage - whether or not

it consists of human, physical, locational, organizational or legal capital - could be expanded in its supply

by competitors, the returns for the firm would be brought down to normal level by competitive pressure

(Teece, 1988).

This consideration leads to adjust the definition of intangible asset, restricting it to the sole resource thatcannot be object of autonomous transactions, so excluding all those assets that, even if by nature

intangible, can be, all the same, autonomously traded (i.e.: a patent or a trademark). According to such

a definition, all intangible assets can be traced to the fundamental categories of knowledge and trust and

the firm can be well defined - paraphrasing Sraffa - as a system to produce knowledge by means of

knowledge (Penrose, 1959; Winter, 1987; Grant, 1996, 2002). Knowledge-based assets are

promising as a source of sustainable advantage because firm-specificity, social complexity and causal

ambiguity make them hard for rivals to imitate.

The accrued intangible assets on one side contribute to increase the perceived value of good and service

provided, on the other side can be either increased and renewed by means of the learning process or

lost when the firm develop entropic processes spoiling its wealth of knowledge and trust. The

knowledge embodied in the organizational systems and procedures and the trust placed by the markets

in the firm constitute the intangible assets - in the strict sense - apt to ensure a sustainable competitive

advantage to the firm.


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The hypothesis discussed in this paper is that the crisis of traditional institutional structures in the main

industrialized countries, together with either local or contingent reasons, may have its common root in

the growing relevance intangibles have taken in the composition of firm's assets.

To be unambiguous, the relevance of intangibles is no actual news, as firm success has always been due

to its distinctive business idea just the same way it has depended on the efficiency of such material

activities as raw material acquisition, manufacturing, sale and distribution. Anyhow, there are some

innovative aspects it is worth stressing:

i) owing to progressive fading of the residual barriers to competition, in more and more industries, the

possibility of creating economic value is qualified by the availability of firm specific assets, eluding

the laws of supply and demand since they are not autonomously negotiable;

ii) as a consequence of innovation in company and intercompany organization (lean organization, total

quality, networks, industrial districts) relevant knowledge is no longer under the direct control either

of the entrepreneurs or top management, as it is also spread at less prominent levels in the company

hierarchy and, outside, by customers and suppliers who become an integral part of an enhanced

business system (Jensen, 1993; Jensen and Meckling, 1992).

iii) growing market integration and a more intense competitive dynamics remarkably rise, in the mainindustries, the critical mass of intangible investments required to compete on wider and wider

markets; therefore, in many firms, the relative weight of intangible assets has reached levels by far

higher than in the past.

3. Intangible assets and corporate financial structure

The growing proportion of intangible components on firm total value radically affects corporate

ownership and governance not only because of the absolute dimensions of the required investments, butalso because of global risk increase due to the specific irreversible characteristics of intangible assets.

In the economic systems based on financial intermediation, where closely held companies prevail, the

rise in the volume of intangible investments required to compete effectively, can make the controlling

shareholders unable to adequately finance firm development. Especially in those industries where

competitive conditions demand conspicuous investments in intangible assets, the survival of companies

with a limited equity-base or even controlled by single entrepreneurial families, has become more and


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more difficult. In the few cases it happens, the controlling shareholders, even when they can rely on

remarkable wealth accrued during many generations, cannot benefit of an effective portfolio

diversification. They are, therefore, considerably risk adverse, hindering intangible assets development,

thence the crisis in governance structures where a single controlling shareholder maintains a leading role

(Capasso, 1995).

On the other hand, those systems based on the security market - though fitter to bear substantial equity-

financed investments - experienced the well-known problems due to the public company as a prevailing

business organization model. Actually, an increasing presence of intangible assets adds further

impediments to public company efficiency because:

i) intangible assets enhance the information asymmetries, that are to a certain extent, irreducible

because their removal could make the firm suffer greater damage due to the disclosure of

confidential facts (Diamond, 1985; Myers and Majluf, 1984);

ii) asymmetric information create a gap between the intrinsic economic value and the market value of

companies, so producing adverse selection phenomena in the capital market (Brennan, 1990;

Capasso 1995);

iii) lack of active shareholders may cause deviant behaviours as executives could use their discretionarypowers in order to maximize their personal utility and manage the company according to their

peculiar risk-adversion, that is usually higher than the average risk-adversion of a well diversified

shareholder (Amihud and Lev, 1981);

iv) some investments in intangible assets are particularly apt either to operate accounting make-ups or

to hide managerial perquisites and unscrupulous behaviours of controlling shareholders; examples

can be provided by the capitalization of useless R&D costs or by those expenses justified by the

rather vague definition ofcompany image.

Furthermore, either in the intermediary-based systems or in the market-based ones, since many

intangible assets cannot be integrated in an autonomously tradable proprietary asset, they cannot be

considered under the direct control of the company, as they are embodied in other stakeholders:

managers, employees, customers, suppliers.

This is probably the crucial remark: the inseparable connection between such relevant assets as

knowledge and trust and some of the main stakeholders could actually subordinate the firm competitive


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effectiveness to the permanence of these stakeholders within the existing business combination. This is

particularly observable in all the companies whose critical factors for success are represented by the

professional capabilities of the staff, but also in those firms owing their competitive advantage to their

belonging either to an industrial district or to a network of interdependent firms.

As a rule, when the critical factors for success in a particular industry are embedded in the main

stakeholders, the company's possibility of safeguarding its intangible asset-base depends on its capacity

in fulfilling the legitimate claims of those stakeholders who are part of its competitive strength.

Stakeholder claims can be, according to the circumstances: wage incentives, occupational security and

good working environment; reliable products, after sale assistance, stable relationships; or more in

general the respect of those implicit contracts and moral obligations that are a consequence of bounded

rationality and contractual incompleteness (Shleifer and Summers, 1988). The higher costs borne to

satisfy such claims are the costs to produce, maintain and strengthen knowledge and trust (Kreps,

1984). They allow the main stakeholders to extract a quasi-rent, rewarding them with returns higher

than the current market value of the resources provided or with products or services more valuable than

the price charged. Obviously, this does not mean that the stakeholders contribution to the value created

is lower than the return they get; it only means that in some circumstances stakeholders get a share ofthe economic value created by the business system, which can no longer be regarded as shareholders

exclusive belonging (Myers, 1990; Charreaux and Desbrires, 2001).

Summing up, the presence of intangible assets modifies the allocation of residual claims as company

performance can substantially affect the wealth of those stakeholders embodying some of the critical

factors for company success; at the same time, intangible assets qualitatively modify the company

financial needs, as intangible assets' higher riskness and their reduced cautional value demand a larger

equity-base (Williamson, 1988).

In order to analyze the interrelation between the two problems and find out possible viable solutions, it

might prove interesting to suggest a systemic approach the company financial structure. From that,

analysis there could emerge reflections on the relation between the formal and substantial aspects of

corporate governance as well as important insights for what concerns the evolution of ownership

structures and governance models.


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4. Systemic value and corporate governance

A systemic reconsideration of company financial structure requires an in-depth analysis of the

relationship between investments and financing decisions, thoroughly investigating the company financial

structure as the premise for the allotment of ownership claims on its future cash flow3.

Several interpretations can be given of this statement. From a simplified perspective, it is easily

understandable that the value of the company investments belongs to shareholders and debtholders in

proportions reflecting the respective contributions and the contractual arrangements. Anyway if we

move our attention on the dynamic nature of value, regarding it as the total amount of future unlevered

discounted cash-flows, we can observe that the debt-equity ratio set the share of operating cash flows

to be assigned to debtholders and the residual amount available for managers. Managers, in their turn

will use it - according to circumstances and in different proportions - either to remunerate shareholders

or to plow back into the business. In other words, the presence of a managerial discretionary power on

the use of free cash flows brings in a further group of agents competing for the allotment of the company

economic value (Jensen, 1986).

The growing importance given by the evolution of competitive dynamics to intangible assets complicates

the problem even more. If the economic cycle of the company is based on accrued intangible assets,that are continuously utilized to produce new intangibles, attainable results will no longer be so

appropriable and transferable as either monetary or monetary-measurable quantities are and their

allotment will not be so easy.

Business economists have traditionally focused their attention on the company value from the

shareholder point of view (Rappaport, 1986), and even the most popular profitability indicators - such

as net income, operating margin, ROE or ROI - measure the company performance in terms of increase

in shareholder equity or in total value for both shareholders and debtholders (Donaldson, 1984).

Truly it is not possible to claim that these approaches belong to an obsolete stage of the industrial

development; there are indeed a lot of companies where - either because of the simplicity of the

production process or because of the strong overlapping among different stakeholder categories - such

parameters as net income, ROI or shareholder wealth, are still the fundamental landmarks for business

management. Anyway, we cannot ignore that for many companies, intangible assets are, to a larger and

larger extent, critical factors for success, and even in many industries usually regarded as traditional,


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hardware components are quickly losing moment with respect to the soft ones, if not in terms of

absolute economic consistency, at least as source of competitive differential4.

The analysis of those phenomena, in order to assess their impact on the evolution of ownership

structures and corporate governance, requires an approach bringing the value of a business system as a

whole within the traditional framework of the company balance sheet. In particular, this can be achieved

by outlining a systemic balance sheet, comparing the value of all the assets included in the business

system with its financial structure, considered in its twofold function of financing source definition and

allocation of claims on expected future cash flows.

The systemic balance sheet has no direct connection with the firm's book, where we find mainly tangible

assets and, only on certain terms, the intangible ones. It is just a way of expressing the identity between

the market value of assets and liabilities. More precisely the asset side displays the market value of all

the resources contributing to the company development, including those intangible assets who are not

directly controlled by the company, such as capabilities and trust it shares with managers, employees,

customers, and suppliers. From this perspective, intangible assets can be divided into three main

categories: firm-based, organization-based and people-based (Exhibit 1).

Firm-based intangible assets are not particularly interesting for the present analysis: a company can usethem at its convenience, as well as transfer them, either temporarily or forever, via autonomous

transactions. The same for people-based intangible assets: since they are not firm specific, they have

autonomous market value. In order to use them a company must remunerate their respective owners on

the basis of what they could have earned if using the same resources in an alternative way (Hall, 1994).

Our interest, therefore, focuses on organization-based intangible assets (shared by the firm's internal

organization and its stakeholders); they are, indeed, the only ones that really fit in the restricted definition

of intangible assets, as stated above. Among them we can distinguish (even if the distinction is not

always clear) relational assets deriving from the relationship existing between the company and its

shareholders and those assets that, even if not autonomously negotiable, can be regarded as parts of the

corporate wealth in so far as they are parts of the company organizational and procedural structure and

do not depend, in some cases, on people working in it. In the logic of valuation, such assets are the

goodwill in the strict sense: it cannot be assessed apart, but must be added to the equity value. As a

matter of fact a differential due to assets that cannot be autonomously assessed but that give an


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important contribution to value creation has always been observed by business economists (Guatri,

1994); anyway valuation models put into practice have only and always considered that part of the

economic value increase pertaining to shareholders or, at the most, to shareholders and creditors

(Copeland et al., 1994).

If on the contrary we want to determine the value of a business system, we must figure out the present

value of future systemic cash-flows, including the above-market returns transferred to the main

stakeholders (quasi-rent5).

The net present value of the so calculated cash-flows can be divided as follows:

i) the market value of each single company-based asset;

ii) the goodwill in strict sense, as the market value of the firm-based intangible assets (pertaining to

equity-holders and debtholders);

iii) the systemic goodwill as the present value of the expected future cash-flows produced by

organization-based intangible assets (pertaining to all the stakeholders on the basis of formal or

implicit contracting).

The liabilities side will show the total amount of debt and equity, at their current market values, duly

quantified on the basis of debtholders and shareholders expected cash-flows. In particular, for listedcompanies, equity can be subdivided in two parts: the former representing the market value of company

share as calculated according to all publicly available information, the latter corresponding either to the

higher or to the lower value inferred on the basis of information available only to insiders (management

or controlling shareholders). The likely unbalance between assets and liabilities represents the systemic

equity that corresponds to the present value of the quasi-rents that will be distributed to the

stakeholders with whom the firm shares the critical intangible assets. Under this perspective, the

systemic equity include the capitalization of those advantages obtained by major shareholders,

executives or employees such as: managerial perquisites, fringe benefits, above-market wages,

overstaffing, but also those benefits provided to customers and suppliers in terms of reduced transaction

costs, as a consequence of a reliable and trustworthy cooperation.

The capitalization of the stakeholders claims on a certain amount of the economic value created by the

business system can be assimilated into an additional equity posting (systemic equity), with a lower

seniority with respect to debt but in any case contributing to the financing of the firm systemic value.


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Such an explanation can find an underlying rationale in the relevant idiosyncratic investments, made by

the main stakeholders in order to enforce their relations with the company. As the value of these

investments would vanish in case the company run into bankruptcy, stakeholders, just like shareholders,

can be considered residual claimants too6.

Moreover the contract incompleteness which can be credited to the intangible contents of exchanged

products and services, has induced to try out new institutional settings in risk and return sharing among

different stakeholders. So contractual or organizational formulas recently carried out can be seen as an

attempt to give some stakeholders an ideal share in the company equity. Such an attribution, even if it

cannot be consider as the allocation of actual ownership claims on company future cash-flows,

represents the substantial (but not legal) premise in order to establish some particular stakeholder

claims.

Obviously a company in default towards its stakeholders does not run into legal consequences, as it

happens in case of default towards debtholders, but it will probably suffer the loss of that part of

company's wealth embodied in the relation between the company and those stakeholders whose claims

have not been met. It is now possible to imagine the systemic balance sheet as it appears in Exhibit 2.

Under this point of view, the stakeholders can be described as a virtual shareholder, contributing themost part of the systemic equity and getting a share of the economic value created by the company.

Therefore, in analyzing real situations, the first problem consists in identifying those shareholders the firm

main intangibles depend on. For instance, it is believable that in a medium-sized family business,

intangible assets are primarily made up of the fiduciary relationship existing among the partners and of

the entrepreneurial heritage, the founder left to her/his heirs. As far as there are no relevant interests of

other people involved, the passing from a traditional vision to a systemic one could not be so important.

Conversely, there are particularly complicated cases in which listed companies carry on business

strongly depending on the competence of individual professionals7.

This is, for instance, the case of advertising firms, merchant banks, newspapers, where conflicts of

interests might rise between virtual and actual shareholders. The origin of these conflicts is mainly in the

fact that virtual shareholders press for being acknowledged, according to circumstances, adequate

relevance either in the allocation of created value, either in corporate governance. Even the liabilities side


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must therefore be analyzed and weighted in order to distribute powers, risks, and returns, among

different stakeholders.

The knotty question consists in ensuring all the shareholders (both actual and virtual) the possibility to

participate or, more plausibly, to control corporate governance. When professional managers are

entrusted with the definition of corporate strategy and policies - and in the major companies no different

solution seem workable - each part must be given, in proportion to contributions provided and risks

borne, the possibility of somehow controlling managerial decisions. This is very important since the

managerial role is actually delicate, as they have to mediate between shareholders and stakeholders. The

obvious risk is that stakeholder theory might be used to cover traditional managerial opportunism, so

largely described in literature (Berle and Means, 1932; Marris 1964; Fama and Jensen, 1983). From

this particular point of view, the suggested methodology can reduce managerial discretion and set a

legitimate limit to stakeholders claims. The acknowledgment of a systemic goodwill as the economic

value created by organization-based intangible assets (due to stakeholders different from shareholders

and creditors) could enable to control that stakeholders' returns exceeding the market value of either the

work done or the resources provided, may take place within the limits of the systemic value that they

originate inside the organization, therefore, without damaging either shareholders' or debtholders'legitimate claims.

Conclusions

In the last decades, corporate governance has become a highly controversial issue and traditional

governance models are everywhere under a complex transformation process. In those economic

systems traditionally based on financial intermediation, governments have worked to strengthen the

security markets by promoting the efficiency and the transparency in negotiations. In market-based

systems, institutional investors, already significant shareholders in many important public companies,

have modified their traditional not interfering in corporate governance and have shown a growing

activism as management interlocutors and controllers (Black, 1993; Bhide, 1993; Pound, 1994).

Furthermore, in most countries, leaving aside prevailing financial models, there have been important

initiatives to regulate the composition and the functions of company boards, aiming to increase their


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representativeness and strengthen their controlling power on the managerial decisions (Cadbury, 1993;

Lorsch, 1995, Pound, 1995).

As a whole, it seems that different corporate models are converging towards a renewed public company

model, with shareholding divided among active institutional investors and governed by an influential

management-independent board. The convergence may be confirmed at least for companies working in

global industries, since, for those companies, the size of the critical mass of intangible investments

demands such an equity-base hardly sustainable, either by a single entrepreneurial group, or even by a

bunch of allied shareholders. In these companies, the institutional investors' involvement can offer

outstanding contribution to the effectiveness of mechanisms that, by conveying to the investors credible

signals, reduce the gap between stock market evaluation and the company actual economic value.

Moreover, further advantages could derive from a clearer distinction between management and board

functions. Executives should be responsible for the company strategy definition and implementation

whereas directors should set goals and play a role of active well informed supervision on the managerial

activities.

In this regard we note a very animated debate about the opportunity of granting the main stakeholders

board representation, according a procedure that is usually followed by many companies and thatsomewhere is required by the law, as in the case of the two-tier board system of the main German

companies.

The theme is controversial: as a general principle, power and responsibility should be closely correlated

in each company. According to such a principle, corporate governance should be a privilege of those

who bear the economic risk (apparently the shareholders). When examining this interpretation more

deeply, we realize it can be shared only by companies where governance implies no delegation

mechanisms and the production process makes use of easily available generic factors whose acquisition

can be regulated by complete (or quasi-complete) contracts. In those organizations where ownership

dispersion compels shareholders to delegate power and responsibility or where the contracts regulating

the acquisition of production means and the sale of goods and services are, for the most part,

incomplete, the economic risk is not exclusively borne by shareholders but by some stakeholders as

well. The intangible nature of the main inputs and outputs of the economic process contributes to

enhance contractual incompleteness and the number of people whose earnings are, residual (Fama and


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Jensen, 1983, Milgrom and Roberts, 1992). The need to reduce transaction and agency costs due to

contractual incompleteness and the presence of intangible assets shared with third parties has made

companies test new organizational solutions, consisting in strengthening relations with customers and

suppliers in inter-company networks and in establishing contractual relations with managers and

employees including the explicit or implicit sharing of risk and returns.

The circumstance for which some intangible assets are not directly available for the company, as they

are shared with other people (managers, employees, customers, suppliers) subordinates their

effectiveness, and even their permanence within the existing economic coordination, to the satisfaction of

those people's claims. The claims are, according to circumstances: wage incentives, occupational

security and good working environment, reliable products, high service level, the respect of tacit

agreements and implicit contracts.

The proposed systemic approach to corporate governance is a working hypothesis, to be integrated

and improved, in order to provide a theoretical framework to evaluate the impact of the growing

importance of intangible assets. Furthermore, the model might allow discriminating the importance of the

different stakeholders and the legitimization of their claims on the economic value created according to

their specific contribution to the corporate systemic equity.From this perspective, stakeholders can be regarded as virtual shareholders whose legitimate claims

have, with regard to the company systemic equity, a relation similar to the one linking the shareholder

expected returns to equity value. The company that does not meet its stakeholders' claims, could lose all

the capital of competencies and trust that is a basic condition to create economic value. Eventually, it

can be interesting to observe how reshaping the stakeholders theory from the point of view of the

systemic value, can help to define possible development ways to the multifaceted debate on business

ethics.

First of all recognizing stakeholders the role of virtual shareholders gives the possibility of making clearer

the relations of correlation and opposition among the various interest focusing on the business, handling

them always within an economic logic. In particular defining systemic value creation as the firm capacity

to continue its production of new resources by means of the previously produced resources, gives

managers a goal that is either sharable by the main stakeholders either ethically correct, since it can


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secure the firm's survival, optimize the use of scarce resources, and maximize the total value produced

for the benefit of the whole economy.

Moreover, the adopted framework could help to identify a fair criterion to classify the stakeholder

interest (Donaldson and Preston, 1995). To such a purpose assigning virtual shares of the systemic

equity in proportion to the contribution given by different stakeholder groups, or by individual

stakeholders to the firm's global value, could reveal possible imbalance in the division of created

economic value.

All that, makes the directors' task particularly difficult since, even if they could be interested party, they

are called to draw up the main contracts, setting up, this way, mechanism to distribute created systemic

value (Aoki, 1980). In this prospective the problem of boards' formation and empowering must be

differently reviewed, that is renouncing to set prearranged representation rules. It is, instead, necessary

to identify those companies or industries where, for certain categories of stakeholders, it is recognizable

a specific significant contribution to the process creating systemic value, so the presence of own

representatives in the board could be regarded as the formal acknowledgment of a virtual participation

in the company equity.


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Exhibit 1

INTANGIBLE ASSETS CLASSIFICATION

firm-based organization-based people-based

Patents embodied in the organization Professional skills

Licences Systems and procedures Generic capabilities

Trademarks Organizational routines Standard know-how

Data-base Corporate culture

Copyright

Industrial designs shared with stakeholders

Supplier/customer networks

Total quality

Learning capabili ties

Innovation capabilities

Product dif ferentation

Customer satisfaction


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Exhibit 2

SYSTEMIC BALANCE SHEET

ASSETS LIABILITIES

DebtTangible Assets * present value of expected future

* current market value of tan ible assets a ments to debtholders* current market value of autonomously

negotiable intangibles

Equity* resent value of ex ected future

a ments to shareholderson the basis of ublicly available

information

Goodwill* firm-based intangible assets

Control Premium

* increase or decrease of the e uit value

Systemic Goodwill on the basis of insider information* organization-based intangible asset * resent value of controllin share-

holders benefits and perquisites

Systemic Equity* resent value of ex ected future

uasi-rent of the firm stakeholders

= VALUE OF THE BUSINESS = VALUE OF THE BUSINESS

SYSTEM AS A WHOLE SYSTEM AS A WHOLE


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FOOTNOTES

1 For a recent survey of theorethical contributions in this field see Becht et al.(2002)2 Academic scholars and practitioners usually discuss of different capitalist models distinguishing theAnglo-Saxon model, based on security market and public companies, from models based on closelyheld companies, long term shareholders and massive bank financing, like those developed in Germany,

Japan, France and Italy (Roe, 1993; The Economist, 1994).3 The concept is well expressed by Jensen and Meckling at the beginning of their well-knowncontribution on agency costs. "We do not use the term capital structure because that term usuallydenotes the relative quantities of bonds, equity, warrants, trade credit, etc., which represent the

liabilities of a firm. Our theory implies that there is another important dimension to this problem

- namely the relative amounts of ownership claims held by insiders (management) and outsiders

(investors with no direct role in the management of the firm)." (1976, p. 305).4 Johnson and Kaplan acknowledge this when they affirm: "A company's economic value is notmerely the sum of the values of its tangible assets, whether measurable at historic cost,

replacement cost, or current market value prices. It also includes the value of intangibles assets:

the stock of innovative products, the knowledge of flexible and high quality productionprocesses, employee talent, and morals, customer loyalty and product awareness, reliable

suppliers, efficient distribution networks and the like....reported earnings cannot show the

company's decline in value when it depletes its stock of intangible resources." (1987, p. 202).5 The concept of quasi-rent, originally introduced by Marshall (1920) is thoroughly explained in all themain textbooks of industrial economics, in particular see Milgrom and Roberts (1992)6 In this perspective it is particularly explanatory to compare the situation of a supplier, who deeplyinvested in transaction-specific assets to develop a stable relation with a particular company, with aninvestor, who owns a certain amount of company shares, holding them in a well diversified equityportfolio. Likely, the supplier's net worth will depend on company performance even more than the

investor's one. Furthermore a possible bankruptcy would hurt with major strength the supplier than theinvestor who can sell his/her shares in a liquid and efficient market at the very beginning of the crisis(Bhide, 1993)..7 According to a respected economic newspaper "The particular problem is how to handle the stockmarket relationship of 'people' business, where not only do all the assets walk out of the front

door every evening saying 'goodnight' to the security man, but often the business has to be

continually recreated because innovation and relationships are more important than franchises

or contracts." (B. Riley "When shareholders own less than they think" Financial Times 19/7/1995).

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