Combining Finance, Strategy, and Corporate Governance

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

Business life has always been filled with a wide variety of events: a success story here, difficulties or even a collapse there, and a spectacular turnaround elsewhere.

Cross-referencing analytical data

The analyst can draw on the bodies of work that have gradually been built up in each of these areas—Finance, Strategy, and Governance—but cannot stop there; he or she must strive to highlight the relationships, which are sometimes conflicting, between these elements of analysis.
This recommendation seems justified to us for several converging reasons:

• On the one hand, the reality of business inevitably calls for bringing together, on common ground, the analyses derived from these different bodies of data, thereby 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 combination can sometimes reveal the conceptual framework—which is sometimes implicit—of these tools.

After reviewing the main connections between the areas studied—a review supported by a few examples—we will present some reflections on current developments.

Fruitful partnerships

To put it simply, we can identify the following key relationships
The business plan and its associated strategy are linked to the governance framework:

• The leaders of a family business that spans multiple generations will be committed to maintaining control of the company; consequently, in their business plan—which underpins the strategy—long-term sustainability will often take precedence, sometimes over profitability and sometimes over growth;
• A startup, on the other hand, will be focused on strong 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 prove to be substantial (see the famous “unicorns”);
• A large publicly traded company, whose shares are widely held—particularly by numerous investment funds, including some 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 those resources externally or to produce them internally. Financial constraints can limit the development of these potential resources and thereby hinder 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 issue in strategy 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 line of business; much like the farmer who prefers mixed cropping to monoculture (following the popular adage “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 divesting 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 to the financier, in the management of his portfolio, ideally composed of N securities from “pure players.”
Which of the two sides is right? Both, in fact, but each for their own institution: the strategic manager for his company, the financier for his investment fund. Their interests are at odds here; so are their conceptual frameworks: organizational sustainability on one hand, the fluidity of financial markets on the other…

The Governance Framework Influences Financial Decisions: Two Case Studies

To illustrate the role of the governance structure 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, in both cases, are strong leaders. If the sectors in question are already mature or on the verge of maturity, internal growth—known as “organic” growth—alone 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 transactions be financed? This is where the governance structure comes into play:

• Company A operates under an “old-school” governance structure, meaning that the CEO wields absolute power over both his internal teams and the board of directors and shareholders. This was the case for many firms and corporate groups several decades ago, such as Antoine Riboud’s Danone (formerly BSN). In such cases, external growth transactions are often financed through share swaps, with Company A offering to pay the shareholders of target company C in Company A shares and, to that end, carrying out a capital increase. It is easy to see the convenience of this financing method, which was used extensively by the aforementioned group; Antoine Riboud even went so far as to say, “BSN’s acquisitions didn’t cost him a penny….” We also know the consequences of relying 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, in fact, the case with the BSN Group, where the Riboud family—which founded one of the original companies—saw its stake drop to a virtually symbolic 1 percent, forcing Antoine Riboud to implement a defense mechanism in the event 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 contemporary companies, including large ones; for example, to cite a recent case, 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 issuance), but above all by relying on debt as his primary means of financing. This policy, aided by very favorable interest rates that lowered the average cost of capital, has—as is well known—resulted in a mountain of debt ($50 billion), plunging the group into serious financial difficulty.

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

On Current Developments

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

• Globalization is a “long-term trend” if ever there was one, having begun in the^16th century with the Age of Discovery, but 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 running parallel to the previous one. It was spectacular 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 kind of “embeddedness” (à la Polanyi) that would be desirable
• Societal issues 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 persistent social inequalities—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,” which may or may not ultimately determine the fate of humanity.

The final and most recent component relates to digital technology, which symbolizes a new Industrial Revolution whose full effects are 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 its own 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 recognition 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 devise 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 of the field of management sciences: this is what this paper has attempted to do for the three selected areas—finance, strategy, and governance—and it would be advisable to extend this approach to other areas, such as marketing, human resources 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 and 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 goal-oriented 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 also holds true for research, including research in management sciences…

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