The Impact on Corporate Governance of the Advent of the Knowledge Economy

With the transition from the Industrial Economy into the Knowledge Economy a formidable series of new challenges come to the corporate governance space. Although this transition has been happening gradually for close to five decades, there was an abrupt inflection point in 2007-2008 that revealed to us how outdated many of our methods in management and governance are. Until then, the old Industrial Economy methods developed over 200 years and fine-tuned as part of the new world order that was established after the Second World War worked reasonably well.

Three key global phenomena happened in the 2007-2008 moment in history, each of which individually would have accelerated the transition but would not have caused a step change – it was that they happened simultaneously that made us change gear from evolution to revolution, particularly so in the financial services sector. The three phenomena are, first, the advent of the Great Recession with the devastating effect it had on the reputation of the financial sector that spilled over to the rest of the corporate world. The second is the technological revolution that came with the coming of age of cloud computing and the advent of the first iPhone and the other smartphones that followed. This led to the creation of social networks and their unplanned side-effect of uncontrolled growth in data that we understatedly called Big Data. Finally, at approximately the same time we had the Millennium generation or Generation Y with the cultural changes they bring, having reached adulthood and making their footprint felt in the workspace and consumer markets.

The conjunction of these three phenomena revealed the preeminence of intangible assets over physical ones, for which our accounting and reporting systems are not prepared. In 1975 83 percent of assets in the Standard & Poor 500 companies were tangible, and only 17 percent were intangible. By 2015 the relationship at the S&P 500 flipped to only 13 percent tangible assets and 87 percent intangible ones, the majority of which are in the form of intellectual capital. How can we govern organisations with reporting systems that give us granular visibility of only 13 percent of assets? Even more important than this from a governance perspective is the fact that intangible assets being shareable radically changed the competitive landscape. While in the industrial era success depended to a great extent on taking control of physical raw materials and other resources and thus confrontational competition, in the knowledge economy no organisation creates value on its own but requires collaboration with multiple other organisations. This requires a radical change in the approach to governance.

The occurrence of the three phenomena reinforced a trend that was already happening, that is that the financial sector like the rest of business needs to become sustainable, by which we mean that businesses need to integrate socially into their community and physically in their environment. As a result of this companies – especially in the Anglo-Saxon financial systems – could not focus only on the interests of shareholders but had to prioritise the interests of a multitude of other stakeholder groups, many of which have opposing interests. Managing the priorities between stakeholder groups is a whole new challenge for governance.

Some of the regulatory changes that came after the 2007-2008 crisis such as Open Banking made incumbent banks lose power and become vulnerable to Fintech. This was reinforced by regulatory changes demanding banks increase their regulatory capital, which resulted in banks letting go their riskier young clients (none other than Gen Y!) who quickly adopted the Fintech alternative. As a result of this the traditional standards for the governance of the financial sector, based on a relatively small number of licensed and highly regulated financial institutions, whose activities were circumscribed to the borders of a nation state, were no longer adapted to the new reality of a sector with a far greater number and diversity of players operating under varying degrees of regulation and many of whom operate cross-borders.

Returning to the happening of the three simultaneous phenomena, the push of the Fintechs and pull of their Gen Y customers triggered the need for financial services to become far more digital in a world of data where risks in cybersecurity are a reality. Cybersecurity, thus, created a series of new demands on corporate governance.

Although the issue of globalisation has been deeply researched in the strategy and operations domains, its impact on corporate governance is far less so. Organisations involved in international business face a specific set of challenges arising from the clash between their governance standards and values defined at the corporate centre, and the societal culture of the host countries where they have subsidiaries or do business. This is particularly relevant in countries where formal institutions are weak and the voids they leave are filled by informal institutions. This has many implications and challenges from the corporate governance perspective that have not been tackled in the literature.

Finally, if one takes the generally accepted Governance triangle of shareholders, Board of Directors and CEO/senior management team, there is significant knowledge on the relationship between the shareholders and the Board of Directors, and on the relationship between the Board of Directors and the CEO/management team. However, there is a third critical relationship in corporate governance which is that between the CEO/management team and the rank and file of the organisation. This relationship is extremely important to development of an ethical corporate culture, one that protects and enhances the intellectual capital of the organisation.

So, the objectives of this module are (a) to shed needed light on the new challenges for corporate governance that derive from the transition to the knowledge economy as described above, and (b) to bring the participants up to speed on corporate governance in an international context and on the importance of the 'CEO vs rank & file' governance relationship.

To focus on the issues, this course addresses the following question: What changes need to be incorporated into corporate governance to cope with the challenges posed by the transition to a knowledge economy?

Topic for reflection: How do you see the advent of the knowledge economy affecting your organization. (Tip: Take each of the factors mentioned in this section and map them on to your market and bank).