Shareholders Should Welcome Knowledge Workers as Directors

32 Pages Posted: 11 May 2006

See all articles by Margit Osterloh

Margit Osterloh

University of Basel; Professor (em.) University of Zurich

Bruno S. Frey

CREMA; University of Basel

Date Written: August 9, 2006

Abstract

The most influential approach of corporate governance, the view of shareholders' supremacy does not take into consideration that the key task of modern corporations is to generate and transfer firm-specific knowledge. It proposes that, in order to overcome the widespread corporate scandals, the interests of top management and directors should be increasingly aligned to shareholders' interests by making the board more responsible to shareholders, and monitoring of top management by independent outside directors should be strengthened. Corporate governance reform needs to go in another direction altogether. Firm-specific knowledge investments are, like financial investments, not ex ante contractible, leaving investors open to exploitation by shareholders. Employees therefore refuse to make firm-specific investments. To gain a sustainable competitive advantage, there must be an incentive to undertake such firm-specific investments. Three proposals are advanced to deal with this dilemma: (1) The board should rely more on insiders. (2) The insiders should be elected by those employees of the firm who are making firm-specific knowledge investments. (3) The board should be chaired by a neutral person. These proposals have major advantages: they provide incentives for knowledge investors; they countervail the dominance of executives; they encourage intrinsic work motivation and loyalty to the firm by strengthening distributive and procedural justice, and they ensure diversity on the board while lowering transaction costs. These proposals for reforming the board may help to overcome the crisis corporate governance is in. At the same time, they provide a step in the direction of a more adequate theory of the firm as a basis for corporate governance.

Keywords: Corporate governance, shareholders, board directors, insiders, firm-specific knowledge

JEL Classification: D23, D83, L14, G34, M50

Suggested Citation

Osterloh, Margit and Frey, Bruno S., Shareholders Should Welcome Knowledge Workers as Directors (August 9, 2006). Available at SSRN: https://ssrn.com/abstract=900344 or http://dx.doi.org/10.2139/ssrn.900344

Margit Osterloh

University of Basel ( email )

Petersplatz 1
Basel, CH-4003
Switzerland

Professor (em.) University of Zurich ( email )

Südstrasse 11
Zürich, CH-8008
Switzerland

Bruno S. Frey (Contact Author)

CREMA ( email )

Südstrasse 11
Zurich, CH 8008
Switzerland
+41 44 380 00 78 (Phone)

University of Basel ( email )

Peter Merian-Weg 6
Basel, 4002
Switzerland

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