Combining finance, strategy, and corporate governance

[The Conversation] - Published on December 11, 2017 in Entrepreneurship, Science and Society

Business life has always been full of events of all kinds: a success story here, difficulties or even a collapse there, and a spectacular turnaround elsewhere.

Cross-reference the analytical data

Analysts can draw on the bodies of literature that have gradually been built up in each of these areas—Finance, Strategy, and Governance—but they cannot stop there; they must strive to highlight the relationships, which are sometimes conflicting, between these elements of analysis.
We believe this recommendation is justified for several converging reasons:

• On the one hand, the reality of business inevitably requires that the analyses derived from these different bodies of data be brought together on common ground, fostering a dialogue between them
• On the other hand, bringing together different perspectives allows us to highlight connections, tensions, and even dead ends in the lives of the firms in question
• Finally, using analytical tools from different corpora in conjunction with one another can sometimes reveal the conceptual framework—which is often implicit—underlying these tools.

After reviewing the key connections between the areas under study—illustrated with a few examples—we will present some reflections on current developments.

Fruitful partnerships

In general terms, the following key relationships can be observed
The business plan and its associated strategy must be linked to the governance framework:

• The leaders of a family business that has been passed down through generations will be committed to maintaining control of it; consequently, in the business plan that underpins their strategy, sustainability goals will often take precedence—sometimes over profitability, sometimes over growth;
• A startup, on the other hand, will be focused on rapid growth driven by the major innovation that led to its creation; it will not hesitate to take significant risks to achieve this (the failure rate for these startups is high); profitability will not be the primary goal—at least not in the short term—because, if successful, it can turn out to be substantial (see the famous “unicorns”);
• A large publicly traded company with a widely dispersed shareholder base—including numerous investment funds, some of which are so-called “activist” funds—will need to pay closer attention to its profitability and justify its strategic decisions to its shareholders.

Strategy and Finance form an inseparable—and sometimes conflicting—pair:
The connection is obvious to anyone who has ever had to develop or analyze a business plan, whether for an individual entrepreneur or for a large-scale project initiated by a major corporation. Any industrial or commercial strategy, in order to be implemented, requires resources and therefore financing to acquire these resources externally or to produce them internally. Financial constraints can limit the development of these resource capabilities and thereby constrain the strategy.

The link between finance and strategy is not merely a matter of quantitative constraints

While strategy and finance are inseparable, they can nevertheless prove to be at odds with one another. One example is the goal of “diversifying the business portfolio,” which has been a classic strategic issue since Ansoff.
As a prudent strategist, a business leader will be tempted to diversify in order to reduce risk, rather than sticking to a single business; much like the farmer who prefers mixed cropping to monoculture (following the popular adage of “don’t put all your eggs in one basket”). The finance professional will take the opposite view, arguing that the company should focus on “its core business” by shedding non-essential activities to become a “pure player.”
Diversification retains its risk-reducing qualities—“diversification must pay,” as statisticians say—but it is not up to the industrialist to implement it, but rather the financier, in managing his portfolio ideally composed of N “pure player” securities.
Which of the two sides is right? Both, in fact, but each for their own institution: the strategic manager for their company, the financier for their investment fund. Their interests are here in conflict; their conceptual frameworks are as well: organizational sustainability on one hand, the fluidity of financial markets on the other…

Governance structures influence financial decisions: two case studies

To illustrate the role of governance structures in financial decisions, let’s consider the case of two companies, both of which aim to become major players in their respective industries within a few decades. This ambition is driven by their respective CEOs, who are, in both cases, strong personalities. If the sectors in question are already mature or on the verge of becoming so, internal growth—known as “organic” growth—alone will not enable them to achieve this goal, which will consequently require external growth through mergers and acquisitions with other companies in their sectors. How can these transactions be financed? This is where the governance structure comes into play:

• Company A operates under an “old-school” governance model, meaning that the CEO wields absolute power over both internal teams and the board of directors and shareholders. This was the case for many firms and groups several decades ago, such as Antoine Riboud’s Danone (formerly BSN). In such cases, the financing of external growth operations often takes the form of share swaps, with Company A offering to pay the shareholders of target company C in Company A shares and, to this end, carrying out a capital increase. We can see the ease of this financing method, used extensively by the aforementioned group, with Antoine Riboud going so far as to say, “BSN’s acquisitions didn’t cost him a penny…” We also know the consequences of this reliance on financing through the issuance of new shares: a dilution effect on Company A’s shares within the combined A + C entity, a dilution that can pose problems for current shareholders, and even for their executives. This was indeed the case with the BSN group, where the Riboud family—founders of one of the original companies—saw their stake drop to a virtually symbolic 1%, forcing Antoine Riboud to implement a defense mechanism in case of an unexpected takeover attempt.
• Company B also has an all-powerful CEO, simply because he is by far the largest shareholder, either directly or through a more or less sophisticated ownership structure. This is the case for many modern companies, including large ones; for example, to cite a current example, the Altice Group, founded and led by Patrick Drahi. Since Drahi is the majority shareholder of his group (with an estimated 60% stake) and intends to remain so, he avoids diluting his controlling power, on the one hand by using a complex ownership structure and differentiated voting rights (ranging from 1 to 15 for his latest share issue), but above all by relying on debt as the primary means of financing. This policy, aided by very favorable interest rates that lowered the average cost of capital, has resulted—as we know—in a mountain of debt ($50 billion), putting the group in serious trouble.

Thus, in both cases, the governance structure had a significant influence on financial decisions.

On current developments

We live in a rapidly changing world, characterized by the interplay of various trends of varying scale and scope. Three of these trends constitute the “deep forces” Braudel refers to: globalization, financialization, and societal challenges

• Globalization is a “long-term process” if ever there was one, having begun in the^16th century with the Age of Discovery, but becoming particularly pronounced throughout the 20th century, despite the wars of that era and the “walls” erected here and there by nations that reject it
• Financialization is also a long-term trend, sometimes running parallel to the previous one. It grew spectacularly during the second half of the^20th century, despite periodic crises. It has gradually come to dominate the economy, which in turn dominates society, in a reversal of the “embeddedness” (à la Polanyi) that would be desirable
• The societal issues at stake seem rather minor compared to previous movements, and one might think that placing them on the same level is an exaggeration. That may be true, but we cannot underestimate the growing awareness—beyond the social inequalities that persist—of societal issues related to ethnic origins, gender, religions, and cultures… as well as the increasingly pressing concerns about the future of the ecosystem, this “Anthropocene” whose fate for humanity remains uncertain.

The final and most recent component concerns digital technology, a symbol of a new Industrial Revolution whose full impact is beginning to be felt. These effects are particularly relevant to the preceding trends, which they tend to accelerate:

• Digital technology is accelerating globalization by facilitating the emergence of new multinational corporations—particularly in this sector (the GAFAM companies)—and by disrupting the business models of other firms of all sizes and across all sectors
• Digital technology is accelerating financialization by facilitating ultra-fast trading (high-frequency trading)
• Digital technology can finally accelerate the consideration of societal issues by enabling the emergence of a global public opinion that reflects the "global village."

It is within this rapidly changing environment—this emerging “new world”—that we must reexamine and rethink the connections between finance, strategy, and governance, not to repeat the successes or mistakes of the past, but to develop new models capable of addressing today’s challenges.

A Call for Multiple Perspectives

As an interim step in this exploration of the bodies of literature on finance, strategy, and corporate governance—and their respective evolutions—it seems advisable to advocate for “cross-perspectives” at several levels:

• Among the subdisciplines within the field of management sciences: this is what this paper has sought to do for the three selected areas—finance, strategy, and governance—and it would be advisable to extend this approach to other fields, such as marketing, human resource management, and information systems…
• Between management sciences (MS) and other established fields of knowledge. In a framework for classifying knowledge based on content on the one hand and purpose on the other, MS, which deal with human organizations, fall within the field of the humanities and social sciences (HSS) in terms of content and, given their applied nature, are, in terms of purpose, closely aligned with other “action-oriented disciplines” such as engineering or health sciences. They must maintain this dual affiliation without favoring one over the other.
• Between researchers and practitioners. Each of these groups has a legitimate basis for expressing their views: researchers through the conceptual and methodological advances resulting from their research, and practitioners through their tacit knowledge and on-the-ground experience. Exchanging perspectives between representatives of each group is beneficial to both.
• Between Socioeconomic and Cultural Contexts: Since this corpus falls within the field of the social sciences and humanities, one cannot apply management science analytical tools without contextualizing them. On this important point, it is necessary to distance oneself from many “made in the USA” studies (in finance, strategy, and governance alike) that mistakenly claim to be universally applicable.
• Across generations. In any purpose-driven human organization, the individuals involved—their personalities, backgrounds, and cultures—sometimes play a major role in the life of those organizations, and it is desirable to foster dialogue between individuals from different generations. This is often observed in business, particularly during leadership transitions; it is equally true in research, including management science research…

Roland Pérez, Professor Emeritus, Montpellier Research in Management, University of Montpellier
The original version of this article was published on The Conversation.

Keywords: Economy, Company