Combining finance, strategy, and corporate governance

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

The life of companies has always been filled with events of various kinds: a success story here, difficulties or even a crash there, a spectacular recovery elsewhere.

Cross-reference the analysis elements

Analysts can draw on the bodies of knowledge that have gradually been built up on each of these components—finance, strategy, governance—but they cannot stop there; they must strive to highlight the sometimes antagonistic relationships between these elements of analysis.
We believe this recommendation is justified for several converging reasons:

• On the one hand, the reality of businesses inevitably requires combining the analyses derived from these different bodies of work on the same ground, leading them to engage in dialogue.
• On the other hand, combining different perspectives allows us to highlight connections, tensions, and even dead ends in the lives of the companies concerned.
• Finally, using analysis tools from different corpora together can sometimes reveal the conceptual framework, which is sometimes implicit, of these tools.

After reviewing the main links between the areas studied, supported by a few examples, we will present some thoughts on current developments.

Fruitful connections

To simplify, we can observe the following major links
The business plan and its associated strategy are linked to the governance system:

• The leaders of a family business that has been passed down through generations will be keen to retain control; as a result, in their business plan underpinning the strategy, sustainability objectives will often take precedence over profitability or growth.
• A start-up, on the other hand, will be geared towards strong growth driven by the major innovation that led to its creation; it will not hesitate to take significant risks to achieve this (the mortality rate of these start-ups is high); profitability will not be the main objective, at least not in the short term, because if it is successful, it can be considerable (see the famous "unicorns");
• A large listed company, whose capital is spread among multiple investment funds, including some so-called "activist" funds, will be required to pay closer attention to its profitability and justify its strategic choices to its shareholders.

Strategy and finance form an inseparable and sometimes antagonistic pair:
The link seems obvious to anyone who has ever had to draw up or study a business plan, whether for an individual entrepreneur or for a large-scale project initiated by a major group. Any industrial and commercial strategy, in order to be implemented, requires resources and therefore finance to acquire these resources externally or to produce them internally. Financial constraints can limit the creation of these potential resources and thus restrict the strategy.

The link between finance and strategy is not limited to quantitative constraints.

The strategy-finance pairing, while inseparable, can nevertheless prove antagonistic. An example of this can be found in the objective of "diversifying the business portfolio," which has been a classic strategic issue since Ansoff.
As a cautious strategist, the business leader will be tempted to diversify in order to reduce risk, rather than sticking to a single activity, much like a farmer who prefers mixed cropping to monoculture (following the popular adage of "not putting all your eggs in one basket"). Finance professionals will take the opposite view, considering that the company should focus on its "core business" by abandoning 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 parties 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 antagonistic here, as are their conceptual frameworks: organizational sustainability on the one hand, financial market fluidity on the other.

The governance regime influences financial decisions: two cases

To illustrate the role of governance in financial decisions, let us consider the case of two companies, both of which aim to become major players in their respective sectors within a few decades. This ambition is driven by their respective CEOs, who are, in both cases, strong personalities. If the sectors concerned are already mature or on the way to becoming so, internal growth alone, known as "organic" growth, will not enable them to achieve this goal, which will therefore require external growth through mergers and acquisitions with other companies in their sectors. How can these operations be financed? This is where the governance regime comes in:

• Company A has an "old-fashioned" governance structure, meaning that the CEO is all-powerful, both in relation to his internal teams and to the board of directors and shareholders. This was the case for many firms and groups a few decades ago, such as Antoine Riboud's Danone (formerly BSN). In this case, external growth operations are often financed through share exchanges, 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. The ease of this method of financing is clear, and it was used extensively by the aforementioned group, with Antoine Riboud going so far as to say that "BSN's acquisitions did not cost him a penny..." We also know the consequences of this use of financing through the issuance of new shares: a dilution effect of Company A's shares in the combined Company A + C, which can cause problems for current shareholders and even their managers. This was the case with the BSN group, where the Riboud family, which founded one of the original companies, saw its stake fall to a virtually symbolic 1%, forcing Antoine Riboud to put in place a defense mechanism in case of an unexpected attack.
• Company B also has an all-powerful No. 1, simply because he is by far the largest shareholder, either directly or through a more or less sophisticated structure. This is the case for many contemporary companies, including large ones; for example, to take a current case, the Altice group created and headed by Patrick Drahi. As Drahi is the majority shareholder in his group (with an estimated 60% stake) and intends to remain so, he avoids diluting his control, on the one hand by using a structure of shareholdings and differentiated voting rights (from 1 to 15 for his latest issue), but above all by using borrowing as his main means of financing. This policy, favored by very favorable interest rates, which lowered the average cost of capital, resulted—as we know—in a mountain of debt ($50 billion), putting the group in great difficulty.

Thus, in both cases, the governance regime strongly influenced financial choices.

On current developments

We live in a rapidly changing world, characterized by the interaction of several movements of varying magnitude and scope. Three of these constitute the "profound forces" referred to by Braudel: globalization, financialization, and societal challenges.

• Globalization is a "long movement," if ever there was one, which began in the^16th century with the Age of Discovery, but became particularly evident 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 accompanying the previous one. It was spectacular during the second half of the^20th century, despite periodic crises. It gradually came to dominate the economy, which itself dominates society, in a reversal of the "embeddedness" (à la Polanyi) that would be desirable.
• Societal issues appear to be much less significant than in previous movements, and it might seem exaggerated to place them on the same level. This may be true, but we cannot underestimate the growing awareness, beyond persistent social inequalities, of societal issues related to ethnic origin, gender, religion, and culture, as well as increasingly pressing concerns about the future of the ecosystem, this "Anthropocene" era, which may or may not seal the fate of humanity.

The last and most recent component concerns digital technology, symbol of a new Industrial Revolution that is beginning to make its full impact felt. This impact particularly affects the previous movements, which it tends to accelerate:

• Digital technology is accelerating globalization by facilitating the emergence of new multinationals, particularly in its own sector (GAFAM), and by disrupting the business models of other companies of all sizes and in all sectors.
• Digital technology accelerates financialization by facilitating ultra-fast arbitrage (high-frequency trading).
• Digital technology can finally accelerate the consideration of societal issues by enabling the emergence of a global public opinion, reflecting the concept of the "global village."

It is in this rapidly changing environment, this emerging "new world," that we must rethink the links between finance, strategy, and governance—not to repeat the successes or mistakes of the past, but to invent new models capable of responding to today's challenges.

Advocacy for diverse perspectives

As part of this reflection on the fields of finance, strategy, and corporate governance and their respective developments, it seems desirable to advocate for "cross-perspectives" at several levels:

• Between the sub-disciplines of the field of management sciences: this is what this paper has attempted to do for the three chosen areas—finance, strategy, and governance—and should be extended to other areas: marketing, human resources management, information systems, etc.
• Between management sciences (MS) and other established fields of knowledge. In a knowledge framework based on content criteria on the one hand and purpose on the other, MS, which deals with human organizations, falls within the field of humanities and social sciences (HSS) in terms of content and, as it is intended to be applied, is close in terms of purpose to other "action-oriented disciplines" such as engineering or health sciences. It must maintain this dual affiliation without favoring one over the other.
• Between researchers and practitioners. Each of these categories has a legitimate voice: researchers through their conceptual and methodological advances resulting from their research, practitioners through their tacit knowledge and field experience. Exchanging perspectives between representatives of each category is beneficial to both.
• Between socio-economic and cultural contexts: as this corpus belongs to the field of social sciences and humanities, we cannot use quantitative analysis tools without contextualizing them. On this important point, we must distance ourselves from many "made in the USA" studies (in finance, strategy, and governance) that mistakenly claim to be universal in scope.
• Between generations. In any purpose-driven human organization, the individuals involved, their personalities, their training, and their culture sometimes play a major role in the life of these organizations, and it is desirable to also bring together the perspectives of individuals belonging to different generations. This is often seen in companies when new leaders take over; it is also 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