Corporate governance and innovation

This chapter reviews the theoretical contributions and the empirical studies linking corporate governance structures and innovation. Both concepts have attracted the attention of a vast community of scholars coming from different disciplinary perspectives. It is therefore important to clearly assess at the beginning of this chapter the boundaries of discussion with respect to the assumptions made on both elements. Corporate governance refers to the set of internal and external control mechanisms that reduce the conflicts of interest between managers and shareholders deriving from the separation of ownership and control (Berle and Means, 1968; Fama and Jensen, 1983; Baysinger and Hoskisson, 1990; Shleifer and Vishny, 1987). A possible approach to the corporate governance problem emphasizes the role of external institutions and organizations in alleviating the agency costs arising from the specialization of management and finance, as in the case of the legal protection given to investors from the risks of expropriation by managers (Shleifer and Vishiny, 1987). However, in this chapter we will explicitly focus on the core internal relationships between managers and shareholders and refer to some critical characteristics in a company’s governance system, such as large individual shareholders, institutional investors, the role of the Government within state enterprises, and the board of directors. Moreover, we will emphasize the implications of the theoretical arguments discussed not only for the relationship between managers and shareholders, but also, within management, between decision makers and executors. We interpret innovation activities as a set of interwoven processes starting with the generation of new knowledge targeted to the discovery of new product and processes, and ending with their commercial exploitation. These processes are multiple, overlapping and performed by a multitude of different actors inside and outside companies, with a distribution of actions and decision making at different organizational levels often difficult to observe and monitor. As a consequence, innovation activities are related both to higher level structural organizational arrangements, and to lower level micro behavioral attainments. The different dimensions of corporate governance structures and instruments cross all these levels, as we will see all along this chapter, create a set of conditions which can profoundly affect the nature and the direction of innovative activities. Economic approaches rooted in Transaction Cost Theory and in Agency Theory rely on the high level of uncertainty characterizing innovation activities, the presence of asymmetric information between the researchers and the decision makers, and the high level of asset specificity generated by dedicated R&D investments, to link governance structures and innovation. The increasing strategic importance of innovation and the concurrent widespread diffusion of several reforms in the international capital markets and in the regulatory frameworks of all major industrialized countries require a deeper analysis of the empirical consistency of these theoretical predictions. Such analysis should also discriminate among the different aspects of innovation activities, as well as the different elements of corporate governance structuring decisions. Starting from a threefold distinction of the latter, in the following paragraphs we analyze to what extent the tension between ownership and control, the role and characteristics of the shareholders, and the role and the characteristics of the board influence the decision to invest in innovation. Building on the most recent results presented by research in economics, strategy and organization theory we offer to the reader a systematic rationalization of usually disperse evidence and introduce formally the research questions which will be further elaborated in Chapters 2 and 3, and investigated empirically in the following chapters.