Taking Cues From the Public Sector

The modern corporation can be traced back four centuries to the formation of the Dutch East India Company, considered the first joint-stock company. On the other hand, democracy has been employed in different parts of the world for millennia. It stands to reason, then, that corporate governance could learn a trick or two from public-sector governance.

That’s the point that is made by Matthias Benz and Bruno S. Frey, assistant professor and professor, respectively, at the Institute for Empirical Research at the Economics of the University of Zurich. In a paper to be published in the January 2007 issue of Academy of Management Review, “Corporate Governance: What Can We Learn From Public Governance?” Benz and Frey contrast four areas of public- and private-sector governance: compensation, division of power, succession and competitive elections.

Politicians typically receive fixed salaries, as opposed to the incentive-laden contracts of most CEOs, ostensibly to ensure that elected officials don’t set policy that they could easily manipulate for their own monetary benefit. But the opposite is true in the private sector, in particular when it comes to equity-based compensation. Having “skin in the game” is supposed to align executives’ interests with investors’ because of the sense of ownership that stockholding endows. But when the vast majority of a CEO’s compensation comes in the form of equity such as stock options, incentives can arise for an executive to manipulate the stock price, and opportunity is plentiful.

To be clear, Benz and Frey recognize that CEOs deserve to be well paid. However, they suggest that a more equitable balance of market-set salary and reasonable equity would reduce perverse incentives.

Another lesson could come from the concept of division of power between managers and shareholders, as represented by boards of directors. In theory, this structure should resemble the checks and balances among branches of government, which operate within parameters that enable each branch to oversee the others.

In practice, of course, CEOs have long dominated the board-room. Even if directors have stepped up their governance in recent years, institutional norms still stack the deck in favor of CEOs. For example, CEOs often dominate the nominating committees that select future directors and usually (in the United States) hold the title of chairman. While these norms may not predict malfeasance, they tend to undercut the concept of checks and balances.