Governance Bundles, Firm Performance, and the Substitutability and Complementarity of Governance Mechanisms

• Published date: 01 September 2009
• Author: Andrew J. Ward,Jill A. Brown,Dan Rodriguez
• DOI: http://doi.org/10.1111/j.1467-8683.2009.00766.x
• Date: 01 September 2009

Governance Bundles, Firm Performance, and

the Substitutability and Complementarity of

Governance Mechanisms

Andrew J. Ward*, Jill A. Brown, and Dan Rodriguez

ABSTRACT

Manuscript Type: Conceptual

Research Question/Issue: This paperextends the theory of bundles of corporate governance mechanisms to address agency

issues within the Anglo-Saxon system of corporate governance. The focus of our study is to detail the role of f‌irm

performance as a key determinant of how the governance mechanisms of monitoring and incentive alignment serve as

complements or substitutes in addressing agency issues. Previous research has looked at these mechanisms in isolation

from each other, with limited regard for the contingencies of f‌irm performance and external monitoring. We propose that

it is best to look at these mechanisms as a bundle of mechanisms to protect shareholder interests, and that f‌irm performance

is a key determinant of the composition of this bundle.

Research Findings/Insights: Weintroduce f‌irm performance as a critical contingency that heightens shareholders’ concerns

over governance issues as they seek to retain control over adverse selection and moral hazard problems. We propose that

when f‌irms are performing poorly, outside monitoring by institutional investors can complement internal monitoring by

boards of directors.

Theoretical/Academic Implications: We examine governance bundles under both agency and stewardship theoretical

lenses to tie together previous empirical research and advance theory. In specifying the role of f‌irm performance in

determining the mix of mechanisms within the governance bundle, we reconcile prior disparate f‌indings as to whether or

not these governance mechanisms act in a complementary or substitutable fashion.corg_766646..660

Practitioner/Policy Implications: The conceptualization of these governance mechanisms has practitioner merit in analyz-

ing the challenges that board members face managing agency conf‌licts through the mix of governance mechanisms, given

different levels of f‌irm performance. Our research also shows that,under conditions of poor performance, shareholders can

provide effective external monitoring that can improve the overall governance effectiveness of the f‌irm.

Keywords: Corporate Governance, Governance Bundles, Agency Theory, Stewardship Theory

INTRODUCTION

Since the work of Berle and Means (1932), scholars and

practitioners alike havestruggled with agency problems

generated by the separation of ownership and control in the

modern corporation. Agency problems of adverse selection

and moral hazard continue to challenge principals due to

two fundamental conditions that underlie principal-agent

relationships – goal incongruence and information asymme-

try (Fama, 1980; Jensen & Meckling, 1976; Levinthal, 1988;

Zajac, 1990). These problems are particularly embedded in

publicly traded corporations under the Anglo-Saxon model

of governance where opportunism is institutionalized and

executives are presumed to be rationally economic (Lubat-

kin, Lane, Collin, & Very, 2005). Agency costs can become

especially problematic when the f‌irm is performing poorly

as the interests of managers and principals have a greater

tendency to diverge in such circumstances (Bebchuk &

Fried, 2004; Walsh & Seward, 1990). In order for principalsto

address these issues, a variety of internal and external gov-

ernance mechanisms are available to monitor agents (Hart,

1995), and the mix of the mechanisms employed is likely

to vary based on the performance of the f‌irm. In this

paper, our primary focus is on the internal bundle of mecha-

nisms that are available to control agency issues under an

*Address for correspondence: Lehigh University,College of Business and Economics,

621 TaylorStreet, Bethlehem, PA 18015, USA. E-mail: award@lehigh.edu

646

Corporate Governance: An International Review, 2009, 17(5): 646–660

© 2009 Blackwell Publishing Ltd

doi:10.1111/j.1467-8683.2009.00766.x