Law & Agency

I currently dedicate most of my research time to a ESRC-sponsored project that has officially finished on May 22nd 2015. The project bears the title 'Law and Agency: The micro-foundations of institutional change in national corporate governance systems' (RES-061-25-0518).  Here is the official abstract:

Law and Agency: The Micro-Foundations of Institutional Change in National Corporate Governance Systems
PI: Dr. Gerhard Schnyder
Much debate has taken place concerning the link between the ‘quality’ of a country’s company law, its financial development and the nature of its corporate governance system. It has been argued that countries with strong legal minority shareholder protection will have well-developed financial markets. This claim has not only influenced the policy recommendations of IMF and World Bank, but arguably directly inspired the legislators in at least one EU country (the Draghi law adopted in Italy in 1998). Surprisingly, few researchers have systematically investigated the impact of changing legal rules on corporate governance practices at the firm level. We therefore know comparatively little about what impact recent legal changes had on companies’ behaviour and how this affects a country’s corporate governance regime as a whole.
The aim of this research is to compare the evolution of corporate governance practices of the largest companies in four European countries (UK, the Netherlands, Sweden, and Switzerland) to legal changes over the last twenty years. The study creates a Shareholder Orientation Index (SOI) of corporate governance practices that is comparable across countries and within countries over time. This will generate new insights into the relationship between law and agency in corporate governance reform.
The study adopts an inter-disciplinary approach that builds on recent scholarship on the role of laws/institutions in the shaping of national business systems and economies. It attempts to integrate insights from legal theory, comparative legal studies, political economy, and sociology to develop a comprehensive theoretical framework that allows us to better understand the role of formal institutions such as laws in recent corporate governance changes and notably in the drive towards more shareholder-orientated corporate governance.
The project therefore aims not only to investigate the question ‘does law matter?’ for corporate governance practices, but also ‘how does law matter?’ In other words, the project critically discusses existing empirical approaches to the link between law and firm-level economic outcomes and proposes a more sophisticated understanding of how law relates to firm level practices in different contexts. In order to develop this framework, the project aims to draw on legal theory as well as various literatures in the social sciences that have increasingly focused on the reflexivity of institutions and the endogenity of legal rules and economic context. The literature on reflexivity or co-evolution also points out that firms are not only ‘rule takers’, but also ‘rule makers’, i.e. they do not ‘suffer’ laws passively, but may actively shape the institutional environment they are active in. The database produced by this project will allow us to empirically investigate such phenomena of reflexivity. In this respect, the project attempts to answer not just the question of how law shapes actors’ practices, but also what role agency (i.e. firm practices) plays in shaping the law.

We spent the largest part of the past four years collecting data on firm level corporate governance practices for the time period 1990 to 2010. We are now turning to analysing the data using various econometric and statistical methods.

At the conceptual and methodological levels, however, we already produced some interesting findings. Two seem particularly promising:

Key finding 1: The sense and non-sense of the use of indices in CG and management research

The key objective of the project was to develop a new shareholder orientation index (SOI) to assess the CG practices in large European companies from four different legal families. This strand of the research involved reviewing existing methodologies of measuring and rating CG practices, including commercial and academic CG indices (CGIs). While previous research on the quality of existing indices has identified different problems related to these methodologies e.g. concerning their predictive power, this research project has generated new insights in that it addresses not just the empirical weaknesses of CGIs, but also the lack of methodological rigour in index construction. This is an aspect of CGIs that has been very largely neglected in the literature. Virtually all existing CGIs, and authors using them, ignore issues of measurement reliability and validity, which are considered key criteria for good measurements in other areas of the social sciences. Therefore, rather than simply following existing methodologies which aggregate individual variables into an index – as was originally planned -, the project turned to explore ways in which to improve the quality of firm-level CG measures. This involved a theoretical and conceptual reflection on CG measurement, but also the search for the most appropriate methodology to create indices. In order to achieve this, the PI attended various statistical training courses at King’s College London and the Essex Summer School in Social Science Data Analysis. As a result of the new statistical capabilities and skills acquired, it has become clear that structural equation modelling (SEM) is a promising methodology which can be applied to the new dataset in order to create valid and reliable measurements of firm-level CG. SEM can also accommodate recent insights into the interplay between CG mechanisms stemming from the so-called ‘bundles approach’. To the best of our knowledge, this constitutes a completely novel approach to index construction in the field of CG research and will hence contribute greatly to the field.

So far, a working paper with the title ‘Measuring Corporate Governance: Lessons from the Bundles Approach’ has resulted from this key finding, which has been included in the Cambridge Centre for Business Research (CBR) working paper series. This is a theoretical-methodological paper, which will be submitted to a major journal. Given that the main objective of the project was to collect the data necessary for index construction, the actual application of SEM to the dataset will take place over the coming months.

As part of the pursuit of this line of research, the PI co-organised a panel on how to measure bundles in CG research. The panel with the title Bundles in CG Research: Implications for Theory and Methods was held at the University of Chicago Booth School of Business during the 26th annual SASE conference. It was co-organised with Prof. Christina Ahmadjian, Hitotsubashi University, Tokyo. Besides the PI, the paper givers on this panel were Prof. William Judge, Old Dominion University and former editor in chief of Corporate Governance International Review (CGIR) and Thomas Clarke, University of Technology, Sydney. The panel facilitated the presentation of the project to an international audience, including world-renowned CG scholars. It has led to regular exchange of information with the participants, which proves to be of great value to the project.

The CBR Working Paper has also been presented at other conferences and invited talks, including at the conference on National Corporate Governance Bundles, Judge Business School Cambridge; London Centre for Corporate Governance and Ethics, Birkbeck, University of London; SOAS; and Linnaeus University, Sweden. The paper can be downloaded by clicking here.

 Key finding 2: The “Law & Finance” school’s “thin” conceptualisation of law

A second key finding relates to the fundamental research question outlined in the research proposal, i.e. ‘does law matter for firm-level CG change?’

As part of the project, a literature review was conducted to identify the ways in which existing studies in the so-called ‘Law & Finance’ tradition empirically and statistically investigate the link between law and corporate outcomes. It soon became clear that most empirical tests of the ‘does law matter?’ question are not based on any consistent conceptualization of how law affects economic outcomes. Indeed, it would seem that the Law & Finance school only implicitly consider this issue and focuses on the classical notion that law impacts economic actors through i) threats or ii) incentives it creates. However, legal scholarship has increasingly recognized that these two traditional channels of impact of law on economic outcomes are not the only ways in which law affects corporations.

A second paper has resulted from the project focusing on this issue. In this paper, the PI uses works in legal theory to develop a typology of channels through which law impacts economic actors. These channels include i) (the threat of) coercion (following Jon Austin’s classical statement), ii) the creation of incentives (as per Oliver Williamson’s Transaction Cost Economics approach), and iii) signalling, i.e. the signalling of what is and what is not appropriate behaviour. The third channel is very largely neglected in Law and Finance, but is well established in legal theory and notably in H. L. A. Hart’s conceptualization of law. The paper argues that these three channels need to be clearly distinguished. The paper contributes to the literature not only by theoretically investigating how law impacts economic outcomes, but also by bringing together legal theory and recent insights in institutional theory in management studies and comparative political economy regarding the reflexivity or endogeneity of formal institutions and corporate practices.

This paper has been presented at three international conferences so far: The 1st annual conference of the World International Network for Institutional Research (WINIR) in Greenwich, UK; The WINIR Symposium on The Nature and Governance of the Corporation in Lugano, Switzerland; and the 27th annual SASE Conference at the LSE. The paper was also presented at a workshop on ‘Corporate Governance: Theory, Reality, Policy’ at the University of Hertfordshire. It can be downloaded here.