The (Un)Predictable Impact of Technology on Corporate Governance
Hastings Business Law Journal | Chiara Picciau
The Centre for Independent Directors at IICA is sharing an article from Hastings Business Law Journal which explores the inseparable relationship between business and technology and resulting impact on Corporate Governance. The emergence of disruptive technologies like Artificial Intelligence, Machine Learning, Big Data Analytics, Advanced computer hardware, Blockchain and Smart contracts which have far-reaching consequences in many fields, including business strategy, competition, the labor market, and even the democratic and political discourse, are presenting great challenge for governance of corporate. Adaptation with these technologies for growth, competitive advantage & value creation while aligning actions with sustainability & ESG aspects which have become centre point of investment strategy of investors, is making governance more important than ever before given the vast potential of influence to every aspect of business strategy and value chain.
From a corporate law perspective, a more compelling reason to consider twenty-first-century technologies disruptive is that they seem to support the long-awaited modernization of corporate organizations and to profoundly change firms’ inner workings. While institutional investors helped introduce some changes in corporate governance, agency problems remain a well-known consequence of delegated management despite technological advances. Artificial intelligence could transform the way directors and officers make decisions in many different ways, from providing informational support to actually substituting them in whole or in part. More generally, common predictions for technology’s impact on corporations vary from forecasts of completely autonomous organizations, run entirely by algorithms, to more limited improvements and efficiencies in the workings of corporate bodies and procedures.
In present form of governance, Shareholders vote on control-related and structural decisions, such as appointing and removing the company’s directors and approving mergers and liquidations. Directors, in turn, are responsible for making business decisions, such as whether to launch a new product or dismiss a supplier, but typically delegate day-to-day management to company executives and officers and retain policy-making and monitoring functions. Unlike past technological innovations, twenty-first century technologies have the potential to alter this balance. Particularly if used in conjunction with one another, they may decisively affect the determinants along which corporate law traditionally assigns power to various corporate constituencies. More fundamentally, new technologies may strengthen existing corporate roles, providing those who already make decisions with new tools to operate more efficiently or, conversely, shift the balance on who is, in certain respects, the best decision-maker within the corporation. The result may not seem revolutionary at first glance, but it foreshadows potentially disruptive consequences for existing corporate governance models and demands renewed attention to ad hoc contractual solutions aimed at redesigning the roles of shareholders, directors, and managers on a case-by-case basis.
I. TECHNOLOGY IN CORPORATE ORGANIZATIONS: FROM DIGITALIZATION TO AUTOMATION
Even though the Internet made it easier to share information and communicate over long distances, shareholders of public corporations haven’t begun to meet more frequently or become more involved in corporate affairs. What changed the most is probably the way corporations disseminate information to the market, both in preparation for the annual general meeting and during the financial year. Information is now readily available on company websites and on publicly accessible databases with the consequence that, at least for public corporations, shareholders have easy access to all relevant documents. Although remote participation in board meetings has entered the routine, these gatherings continue to be held physically in many cases. Importantly, face-to-face meetings and phone conversations are still a very frequent form of private engagement between the company and its institutional investors or control shareholders, despite the increased availability of digital tools.
Recent research has typically addressed either how big data, algorithms and artificial intelligence may affect managerial decisions or, alternately, how blockchains and smart contracts may be employed to make shareholder meetings more efficient. Clearly, since artificial intelligence and algorithms, frequently working on big data, are decision-making tools, their most immediate application concerns those corporate constituencies—directors, officers, and managers—who usually make decisions. Similarly, since blockchains are distributed ledgers upon which computer programs may execute transactions (so-called “smart contracts”) their most immediate use concerns shareholder identification at corporate meetings, the recording of share transfers, and the administration of voting procedures.
Blockchains and smart contracts, in their simplest version of coding instructions (such as “if A, then B”), may lead to a variety of corporate innovations, ranging from the digitalization of company reporting and procedures to more structural developments in the role and functioning of corporate bodies, especially the shareholder meeting. Blockchain technology could improve tracking of internal accounting information, entrusting managers, auditors, and other chosen parties to validate recordings. Significantly, disclosure of accounting documents could be provided on a selective basis, grouping identified recipients in “aggregation levels” that would obtain access to predetermined parts of the blockchain depending on their role. Computer programs could then build accounting reports and financial statements based on the blockchain recordings in a traceable and verifiable manner. This system greatly reduces the risk of accounting manipulation, documentation error, and fraud by adopting a triple-entry accounting mechanism: Transactions are recorded by the two parties involved and by an independent intermediary, represented by (all the nodes in) the blockchain.
II. CORPORATE ROLES AND THE BEST DECISION-MAKER PROBLEM
Stricter rules on board composition, independent directors, executive compensation, and so forth have been deployed as a panacea for all corporate problems. Legal reforms, however, are not the only determinants of corporate governance; they are, in a way, built upon other transformations, which indirectly contribute to affect the internal workings of corporations. The new technologies have the potential to introduce similar changes in corporate governance by affecting one or more of the fundamental determinants along which corporate law typically distributes power between shareholders, directors, and managers. These include factors that relate to the way decisions must or should be made, such as the timing and frequency of the decisions, the availability of the necessary information, and the costs of deciding, as well as factors that are more deeply connected with the personal features of the decision-makers, such as their incentives, competence, and skills.
Decision-making power within the corporation is distributed among “a board of directors, which manages the corporation’s business; officers, who, as agents of the board, execute its bidding; and shareholders, who elect the board” and decide on fundamental changes and transactions. In modern public corporations, the board of directors mostly performs a monitoring and policy-making role in the interest of the shareholders, delegating operational decisions and day-to-day management to a team of appointed officers. If decisions must be made frequently, directors and officers are in a better position than shareholders to make them. Officers may do so on a daily basis, devoting most of their efforts and time to the corporation. The board of directors, as the corporation’s monitoring and policy-making body, may also act relatively frequently.
Another way of looking at how power should be split among corporate bodies is to ask who has the best incentive to decide or who is less prone to opportunistic behaviors and conflicts of interest. For instance, stockholders are said to have the best incentives to decide on structural decisions, such as mergers or liquidations, because their investment is at stake. In contrast, directors might oppose these decisions, especially if they know or expect that they will lose their jobs afterward. Directors also have distorted incentives when it comes to control decisions, such as the appointment and removal of board members, changes in voting rules (e.g., the introduction and regulation of cumulative voting or slate voting), resolutions on the information flows to stockholders, and so forth.
III. THE IMPACT OF TECHNOLOGY ON THE DISTRIBUTION OF CORPORATE POWERS AND RESPONSIBILITIES
The new technologies help reduce asymmetries of information and extricate communications from corporate management’s exclusive control. Blockchains and smart contracts could, for instance, make corporate documents and data more readily available to shareholders and directors, while at the same time preserving the integrity and authenticity of the information. Technology could therefore contribute to make shareholders and the board more informed about management’s conduct, with potential repercussions on the allocation of monitoring responsibilities.
