Corporate Governance: between Art and Profession
In this editorial, published in 1994 in issue number 1 of Economia&Management , the founder of the magazine addressed the issue of corporate governance as a balance between art and science. Here we find not only Demattè's approach and philosophy, but also one of his main teachings: that managing businesses means understanding collective action, and it is not sufficient to trust only reason, but also sentiment and passion.
Claudio Dematté wrote approximately 90 editorials: in every issue of the magazine, from its founding for seventeen years until his sudden death. As he himself recalled, it was "a periodic appointment that, as soon as kept, already pushed and absorbed one to define the next theme." Choosing one from among these is very difficult, in part because Dematté used the pieces to express his reflections deriving from his activity as a teacher, scholar, and manager, with a perspective not limited strictly to current issues but with the programmatic intention of "focusing on the great changes that are triggered by the dynamic of small and large events/actors of all of the species that populate the world." It is thus impossible to capture that complexity in a single article, and we invite the readers to read the other editorials as well in our archive. Having to choose one, and only one, we propose the one below, which came out in issue 1/1994 of the magazine, on corporate governance as a balance between art and science. In this editorial, we find not only Demattè's approach and philosophy, but also one of his main teachings: that managing businesses means understanding collective action, and it is not sufficient to trust only reason, but also sentiment and passion. This is a precious teaching, that as he often reminded us, applies not only to businesses.
Almost an art, more than a profession: this seems to be the nature of the function of governance, including the governance of a business. Stating that it is almost an art is disquieting for those who work in the world of academics and research: it seems less like enhancing the activity, and more like diminishing it. It appears as something which cannot be studied, generalized, or repeated; and thus something that is not scientific, not worthy of that world that presumes it can be legitimate only if it cultivates science.
The truth is different: saying that governance is an art – or that governance is also art – means recognizing the complexity of the function and the impossibility to limit it to a fixed scheme. It does not at all mean denying the ability to study it; nor does it mean giving up when faced with the infinite variety of specific cases, excluding the possibility to forecast probable paths, in light of the analysis of past experience. Rather, it means admitting that the variables that intervene around problems of governance are so numerous, and their interrelations so complex, that it is not possible to use the laws of mechanics to identify the expected outcome.
The essence of the art of governance
To govern, it is necessary to discover and construct, day after day, the conditions that make the survival and development of an organization possible. Some of these conditions can be defined almost as biological laws: they are laws that allow the organization to maintain its links with the critical resources it needs.
These include the laws of economic, financial, and asset equilibrium. They define the terms to be met to obtain the infusion of capital the company needs. Laborious research has been conducted to define the cost of capital; or, if viewed from the opposite perspective, the return that must be offered to those who provide this factor of production in the different risk configurations the business assumes.
Some of these "quasi laws" reach the point of also identifying with a high degree of plausibility the optimal combinations of risk capital and loan capital that ensure the best conditions of equilibrium in the various business configurations.
Unfortunately, the search for the overall point of equilibrium of a business entails much more detailed work than that of finding the conditions to be satisfied with respect to one interlocutor (in the case just seen, the funders). Every organization, every business is a body that exchanges different resources with multiple subjects: it receives work from some and compensates them with salaries and other benefits; it receives raw materials from others in exchange for present or future payments; to others it gives products in exchange for revenues; from others it receives licenses, permits, or whatever else is necessary to operate under law.
Every exchange is an act of negotiation. As such it is also an act of confrontation, in which there is measurement of the subjects' respective points of convenience and contractual power. Every act of exchange has a positive or negative value not in absolute terms, but as a function of the outcome that will be produced by many other acts carried out to complete the entire production process. Thus it is not possible to know with certainty a priori if a purchase will produce value or reduce it; it depends on the use made of the asset purchased and the outcome of the final act of sale.
Since management is made up of a multitude of single acts of purchase, countless actions of transformation, and various sales operations, each of which contributes to forming the overall result, the art of governance consists of providing each person who intervenes in the process the points of reference to harmonically compose their choices so as to obtain – at the end of the process – full satisfaction for all of those who have participated.
The convention is to positively consider outcomes that entail a profit at least sufficient to satisfy the contributors of risk capital. The outcome is judged to be even more positive if it has produced an even greater profit than that anticipated by the shareholders. The reason why all of the attention concerning management quality is concentrated on the remuneration of risk capital regards the form in which this factor participates in the production process: its compensation is not predefined, but is what remains after having remunerated the other factors that are conventionally presumed to be satisfied with what is granted them.
For a more complete evaluation, it is necessary to determine if the profit has been reached by sacrificing the compensation of factors of production that are equally critical for the development of the business. The ultimate test should thus be that of equilibrium with respect to all of those who participate directly or indirectly in the business process.
This is where the concept of equilibrium arises: a concept that is difficult and perhaps too vague to allow for rigorous treatment, despite being located at the heart of economics.
In reality, affirming that the essential question is how to succeed in maintaining a point of equilibrium towards all of the subjects that make up the organization or contribute to its survival, even if they are outside of the organization itself, means returning to the concept of exchange.
Maintaining a point of equilibrium means preserving the possibility to continue exchanges in the future, thanks to the fact that the result of the exchanges conducted to that point is considered satisfactory for the subjects involved. In other words, it means that one has succeeded in offering conditions equal to or better than those of equilibrium on the various procurement and sales markets in which the business operates.
All of those who actually conduct operations on the markets know that markets are not perfect. They know that many of the exchanges in which businesses are involved are sticky, with one or the other party partially or fully captive, to the point that they are forced to accept conditions below market equilibrium. Think of the position of certain suppliers, who are structured to serve a specific client, and the impossibility of rapidly finding alternative outlets to act as a specialized contractor. Think also of the position of workers who could have more convenient employment prospects, but only by accepting a move that would entail changing location.
In these conditions of an imperfect market, the test of good governance cannot stop with the verification of whether adequate profits have been earned; it must also determine whether obtaining these results has created situations that could subsequently lead to the business being detached from factors of production not satisfied with what they were given during the process, but that are precious for the development of the business.
Corporate governance as the construction of new combinations and new forms of equilibrium
In reality, corporate governance is also more than what we have stated to this point. It is certainly the search for a point of simultaneous equilibrium with all of the subjects that intervene in one way or another in the business activity. In its more entrepreneurial vision, it is also the continuous search for new, more profitable opportunities for transformation and exchange.
From that perspective, it is the identification of something that did not previously exist: a new need, a different productive combination, a new factor of production, something that alters habitual conditions of exchange at the root, creating new prospects. From this viewpoint, corporate governance is not the construction of a point of equilibrium at given conditions, but rather the breaking of old situations of equilibrium to construct new ones. It is no coincidence that in recent years, currents of discussion have emerged that stress this aspect of good management: the constant pursuit of new, increasingly advanced points of equilibrium with respect to those at which competitors are located.
Some scholars take extreme positions, by denying that the art of governance is the search for points of equilibrium, but rather that of voids in the market, those points of unsatisfied demand on which a market has not yet formed. Others argue that the essence of governance of a business consists of constantly building new skills and new challenges; the only ones possible to discover new needs, offer new products, invent new production combinations, and mobilize energies towards new forms of equilibrium.
A more careful reading allows for avoiding the extreme dichotomy, to recognize that the art of governance encompasses both of these aspects together: it is maintaining the equilibrium on already-formed markets and at the same time discovering new prospects for exchange that reside precisely where nobody had ever previously found the spark to produce mutual convenience.
We have seen that the function of governance was already complex when the need was to identify the points of simultaneous equilibrium on different, already-configured markets. What can be said when this also entails the construction of new opportunities for exchange, generating new ties between markets of factors and markets of products, thanks to new production combinations and the construction of new skills?
The only thing that can be said is that it acquires an additional dimension that pushes it away from merely technical functions, to project it in other directions.
The function of governance with respect to the a priori non-calculability of ultimate outcomes
While the exercise of the function of governance has the characteristics described above, the result is to question the possibility of pre-define the ultimate results which choices will produce, at the time the choices are made. This is equivalent to asking if entrepreneurs and those who are responsible for the governance of an entire business trigger a process – at the time of each single choice – that explores the effect of the choice down to its ultimate consequences.
To go even further, there is the question of whether every choice is assessed in light of the many other choices that will have to be made to complete the entire production cycle. In brief, we ask if the final result is "calculable," constructible, and predictable, or if it is nothing more than the unconscious summary of a sequence of disjointed choices; an almost casual result, without the merit of having been constructed with intelligence.
The question is not insignificant: the response has implications for the possibility to construct a system of research and training around the activity of governance. It also determines the transmissibility of the knowledge that is triggered by the study of the experience of people who are about to assume governance responsibilities. Another element is the possibility for those who govern a business to learn from the exercise of the function, drawing "laws" and "sensitivities" from the experience that improve their future actions. An in-depth reflection on the question suggests that if the governance of a business is what we have stated to this point, it is made up of, or breaks down at least into two operations:
- the exact calculation of the point of equilibrium on the single procurement or outlet markets or towards other single interlocutors that are crucial for the business activity;
- the evaluation of the overall static, but above all dynamic equilibrium.
As regards the first type of operations, there are the known difficulties we have already mentioned. Sophisticated techniques sometimes exist to identify the solution: just think of the systems of segmentation, pricing techniques, the calculations for optimization of plant load, and systems for controlling the cost of capital.
In brief, there are techniques capable of "assembling" the various elements that influence a process to evaluate the result, and they are continuously being improved.
Given that they deal with questions that are part of a more general system, these techniques cannot claim to provide solutions independent of the structure of the rest of the system. So they are intrinsically imperfect. But they have the possibility to approximate the outcome of the choices on which they intervene; at the least, they are able to indicate the spectrum of possible solutions in light of the alternative states of the rest of the system.
It is not surprising that research has flourished on this front, and that most managerial disciplines rest on it. This activity leads to ideas and techniques that prepare those who are about to perform management functions, starting from covering a specific company function, as it properly should be.
Yet the art of governance is not exhausted here. It is not exhausted in this "calculation" either as regards the single choices, if it is true – and it is – that the problem does not consist only of finding points of equilibrium with given situations, but also of constructing new production combinations able to generate value for all of the subjects that are involved.
In that case, even the exercise of a specific function – and not only that of overall governance – requires the foreshadowing of new realities around which to apply the "calculation" of the point of equilibrium. In brief, it preliminarily requires a vision, that is, a non-scientific, but creative act on which to then exercise the discipline of evaluation.
It goes without saying that this creative element of governance activity is present to the greatest extent where it is necessary not only to find the response to specific functional questions, but to construct and evaluate the overall business equilibrium. In this case, it is necessary to pre-figure the possible state of all of the variables at play, to mentally hypothesize their different combinations, and lastly, to calculate the result of the different combinations.
We cannot miss the fact that the task appears of a nature that makes us doubt its "calculability." It is equivalent to the solution of complex systems of equations after having imagined the unfurling of the countless variables involved and their mutual relations. Integrated planning models, system dynamics techniques, and simulation tools have been conceived and experimented to give this activity tools that at least in part reduce the apparent indeterminability.
It also does not seem advisable to try to test the complexity of corporate governance seen in its dynamic and entrepreneurial approach: in an area where the goal is not to simply find a point of equilibrium with respect to an existing reality, but rather to construct new realities and new points of equilibrium.
It does not seem advisable, because it becomes entirely clear that it is an activity which combines the art of prefiguration with that of complex calculations.
The discussion above highlights some points on which to reflect. First of all, the fact that governance activity is exercised at various levels with different degrees of breadth. Secondly, that it is at all levels a sum of "calculation" and creativity. Thirdly, that it can certainly not be exercised with the exclusive use of techniques, but that these are however fundamental. Lastly, that precisely due to this nature, the art of governance is a function that is not only technical.
Since the ultimate outcomes are the result of a multitude of acts of creativity and calculation of all of the subjects involved in the business activity, its ultimate essence is the creation of a context in which this sum of activities is harmonically composed, providing the maximum impetus to creativity and the ability to evaluate the compatibility of the single positions with respect to the general equilibrium.