agency theory in cu

8/12/2019 Agency Theory in CU

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GOVERNANCE IN DEMOCRATICMEMBER-BASED ORGANISATIONS

by

Roger SPEAR*Open University, Milton Keynes, UK

ABSTRACT**: This paper considers issues of governance in

democratic member-based organisations (DMOs), such as co-operativesand mutual societies. It examines the processes whereby members

interests are mediated through the democratic process, and the

board; and it explores some of the factors influencing the power

of managers. It goes on to argue that the system of governance in

DMOs in their institutional context runs the risks of managers

becoming powerful and entrenched in poorly performing

social economy organisations, unless countervailing measures are

adopted.

1 Introduction

The paper focuses on the governance of democratic, member-

based organisations (DMOs). Essentially the paper is relevant to awide range of organisations that serve a membership and give that

membership democratic rights of governance, such as co-operatives,

mutual organisations, trade unions, and voluntary sector organisa-

tions where the membership is formalised and given democratic rightsof control in its constitution. (However, as Lansley (1996) argues

in those voluntary organisations which are charities the historicaldevelopment of charity law has tended to marginalise members in

relation to trustees and management). Most, but not all, DMOs accorddemocratic rights to members on the basis one person one vote,

rather than on the basis of shares held. This excludes most

commercial share-based enterprises. Nonetheless, the paper draws

* [email protected]

** Resume en fin darticle; Zusammenfassung am Ende des Artikels;

resumen al fin del artculo.

#CIRIEC 2004. Published by Blackwell Publishing Ltd, 9600 Garsington Road, Oxford OX4 2DQ, UKand 350 Main Street, Malden, MA 02148, USA

Annals of Public and Cooperative Economics 75:1 2004 pp. 3359


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on some of the approaches to corporate governance in such organi-

sations.

The current concern with organisational/corporate governanceis widespread. In the private sector the reasons for this include the

following:

- excessive executive power which may culminate in pension

fund abuse, excessively large remuneration packages for execu-

tives, corrupt practices as well as poor decision making;

- a concern that systems that attempt to enable owners to

exert control over managers have often been ineffective and

cumbersome;- a concern that with increasing globalisation of corporations

and the relatively weak regulatory powers of national

governments that some effective constraints on the power ofcorporate managers is required;

- an increasing concern for the environment and market fail-

ures for common property (tragedy of the commons); and so

placing greater demands on good stewardship;

A similar picture emerges in the social economy (co-operatives,

mutuals and voluntary sector). Examples of the current concerns

are most visible in the periodic reviews on Co-operativeGovernance in the UK Co-operative Sector (by the Co-operativeUnion now Co-operatives UK (19762001), and the recent spate

of privatisations of mutual societies which has involved conversions

to PLC status to increase commercial flexibility and gain access towholesale capital; this has also led to lucrative share options for

executives and share windfalls to current members where they

benefit from the accumulated capitalisation of the business over

several generations of membership. Other concerns in the social

economy are to do with degeneration of co-operatives (specificallyof their values and distinctive practices), a tendency to insularity,and the processes or political levers for promoting change in

governance.

This paper continues by outlining some of the major theoretical

perspectives on corporate governance. Using this framework it then

examines the nature of governance in DMOs and some of its charac-teristic weaknesses, including low levels of member participation and

managerial entrenchment. Finally, it goes onto develop prescriptions

for better governance of DMOs designed to overcome some of theweaknesses identified.

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2 Approaches to governance

This section outlines some of the main themes in the corporateand non-profit governance literature, then goes onto locate the

approach adopted in this paper in relation to these themes.

The policy context for designing or adapting governance sys-tems is: a recognition of the power of (often deregulated) markets in

shaping corporate action, varied institutional frameworks for corpor-ate takeovers in different countries, government regulatory frame-

works (which are often weak). This leaves an emphasis on business

ethics, and regulatory/advisory frameworks for corporate governance

(the main features of which are concerned with the role and composi-tion of the board, and the ways in which it can exert control). This

paper is concerned mainly with governance (and to a limited extentregulatory frameworks).

There are several schools of thought in the literature on govern-

ance. This paper will refer to a few of the major ones relevant to itsdomain of interest democratic member based organisations. The

first has its origins in the work of Berle and Means (1932) whichasserted the dominance of management and the legal fiction of share-

holder control, and the ineffectiveness of the board in checking man-agerial power in the interests of shareholders. The second major

trend, which is used to structure the analysis in section 3 of this

paper, is principal/agency theory (this whole section draws on, but

also develops and adapts writings on principal/agency theory andtransaction cost approaches such as Ben Ner and Van Hoomissen

(1994), Jensen and Meckling (1976), Hansmann (1996) and Morse

(2000), etc). This theory is based on similar assumptions of powerfulmanagers, and it develops a normative approach for limiting manage-

rial power and guiding its direction. P-A theory is particularly usefulfor structuring and informing an analysis of the influence of mem-

bers/owners (the principals) over the managers (agents) in DMOs. It

is concerned with economistic, rational-choice theories of how the

principal (usually determined by property rights i.e. the owner/mem-ber) can control the agent (the manager of the enterprise) so that the

agent manages effectively in the principals interests. Principalagency theory has been extremely influential, particularly in propos-

ing changes to governance processes; and it can be seen informing a

range of measures such as codes of practice and share option schemes

for senior managers.

Third, there are stewardship approaches (Davis et al. 1997) that

examine the role of managers in relations (of partnership) with

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diverse stakeholders of the organisation. These approaches are often

normative, looking to inform good management practices, rather than

controlling them. One such approach is that of Kay and Silberston(1995) which proposes atrustee model of governance, where manage-

ment are seen as trustees of the firms assets. As with the above

approaches, this approach has the advantage of fitting closely withmost observers views that management is by far the most powerful

actor in the governance/management process. This approach is criti-

cally examined in Section 4, particularly in relation to expanding theview of a firms assets to include its core values and the democratic

rights of members thereby expanding the view of governance.

There are also numerous studies of factors influencing the per-formance and effectiveness of boards, including the specification of

different roles of boards and in particular the competency of board

members (e.g. Westphal and Zajac 1995, Stone 1991, Fletcher 1992,

etc). These are not central issues for this paper.

Some recent researchers e.g. Pettigrew and McNulty (1995),

and Cornforth (1996, 2002) argue that there is relatively little

research on how governance is actually conducted and in particular

the operation of boards has been a black box for too long. Pettigrew

and McNulty (1995) develop a framework for analysing power andinfluence at board level in terms of three sets of factors: context andstructure, power sources, and will and skill. This suggests that the

wider institutional, legal, and societal context shapes directors inter-

pretations of their role and conduct. A board member may draw on

various power sources to develop a credible power base relevant

expertise, derived power from internal/external power figures, posi-

tions on board committees, and influence arising from informationand networks developed within and outside the boardroom. But

clearly the will and skill of board members differ considerably in

both their ability to build and develop power sources and to makeeffective use of them (using sound analysis, persuasion, persistence,

tact, charm, etc).

Finally, partly from such empirical considerations and partly

out of a concern for a need to integrate theoretically the diverse

perspectives on governance, attempts have been made to bring

together some of these approaches in a way that informs the complex-

ity faced by boards and manager. Such more integrative approaches

that bring together theoretical perspectives (e.g. Cornforth 2002,

Sundaramurthy and Lewis 2003, etc.) seem highly relevant both forimproving theoretical understanding of governance issues, but also

for assisting in normative concerns for the better design of governance

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systems. With regard to this papers concern for democratic gover-

nance in social economy organisations, it seems particularly important

to address issues both of participation of members (see Birchall (2002)for an important contribution), and how they exert influence or

control over managers, but also to consider how this relationship can

be developed through co-operative/collaborative relations.

Sundaramurthy and Lewis (2003) argue that in order to under-

stand governance performance it is necessary to develop an approach

that combines both control perspectives (e.g. P-A theory) and collab-orative perspectives (e.g. stewardship theory). They also argue that in

the design of governance systems that an over-reliance on one of these

perspectives can lead to a self-reinforcing dynamics leading to poorperformance thus a balance is required:

A control approach helps curb human limitations through vigilanceand discipline, while a collaborative approach taps individuals

aspirations via cooperation and empowerment. Yet if one approach

becomes overemphasised, perils of groupthink or distrust can fuel

reinforcing cycles. From a more integrative perspective, however,

embracing and balancing both approaches facilitates learning and

adaptation. Sundaramurthy and Lewis (2003)

This framework is used in this paper, firstly to outline the natureof control in DMO governance, then to explore the need for a trustee(collaborative) model of governance in order to balance out the defects of

limited member control. The paper concludes by exploring further meas-

ures required for the design of effective governance systems in DMOs.

3 Members control?

In this section the control perspective on the governance ofDMOs is explored using P-A theory and secondary data. In P-A

theory, the principal has three ownership rights:

- to control the organisation,- to dispose of itspayoff(in whatever form), and

- to transfer these two rights.

This paper is mainly concerned with the first right (control of

the organisation) but the other rights also have a bearing on the

argument. Typically the influence of the members (the principal)

is not direct, but via a board of directors representing the membersand via an annual general meeting, where directors are elected and

major issues are discussed. Thus it is convenient to split the analysisin this section into three parts: members influence on the board,


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board influence over managers, and external factors influencing

governance namely the market for corporate control, legislative/

regulatory frameworks and professionalisation processes.

3.1 Members and boards

In this section secondary data (mainly from UK consumer co-operative sector and direct from UK co-operative societies) is used to

examine the extent of member influence over the board, an aspect of

governance which has tended to be under emphasised in governance

research. Data from consumer/user co-operatives in the UK is used,

with some comparative data from the other sectors and countries.Five issues are addressed examining different points in the logic of

influence from user/consumer to the board:

- the proportion of users/consumers with member rights;

- member participation;

- the effects of size and age on participation, which examines

the extent to which a decline in participation can be consid-ered a result of size or age;

- coalition formation;

- board functionality.

Proportion of users/consumers with member rights

This refers to the relationship between customers and mem-

bers. In some retail consumer co-operatives, such as in Japan, all thecustomers are members, and vice-versa i.e. there is an identity

between the two. This identity principle still applies in the case of

most financial mutuals, including credit unions. However many con-

sumer co-operatives have lost this principle, so that there are some

members who are not consumers (because they have moved away,

died, etc), and there are many consumers who are not members eitherbecause they lack the interest or the opportunity (because the

co-operative has not been promoting membership vigorously).

These conditions can be seen in Figure 1.

Where the identity principle applies it may lead to complacency

about membership issues since promoting membership becomes anunnecessary task. Many financial mutuals, such as building societies

in the UK, hardly promoted the concept of membership, and certainlynot active participation, until the wave of demutualisations in the

nineties. The situation has improved in recent years in that sector,

and in the consumer co-operative sector for example one regional

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society has written off 42% of its previously recorded members (due tothem having lost contact with the society), and now just over 50% of

their trade is with members (Co-operatives UK 2003). And there are

now new policies in place for increasing the proportion of trade withmembers of consumer societies.

Where the identity principle does not apply, there are two

issues: firstly the proportion of customers who are members thelower the percentage the less representative they are of the customer

base; and secondly the proportion of members who are not customers

assuming most of these are dead or have moved away, this may givea false impression of scale of membership and its characteristics; there

is a minor risk of entryism people becoming members for political

reasons or to secure personal advantage.

Member participation

Recent data on UK consumer co-operatives (Davies and Donald-

son 2001) shows a range of 15% of members participating in board

elections. Most societies report less than 1% of members voting in

members meetings, but the range is still 15% for the full spectrum ofsocieties, and there was some evidence of size effects with larger

organisations tending to have lower participation levels (Figure 2).

Customers

members

Figure 1 Showing incomplete identity between members and customers

0

5

10

Under 1% 1%2% 2%5%

% Members attending

No.

Societies

Figure 2 Percentage of members attending members meetings


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The Oxford, Swindon and Gloucester Co-operative (OSG) is the

largest regional independent retailer in this geographical area with an

annual turnover of 296.7 million (the fifth largest UK retail co-operative in 2002), 190,701 registered members (70,044 active, regu-

larly trading, members) and 3,603 employees. 8,665 members voted in

the Societys AGM in 2002. This voting represents 4.54% (of mem-bers). The OSG policy over the years of promoting membership by

targeted recruitment and the introduction of a dividend card has

clearly paid off (together with postal voting).

Lincoln Co-operative Society, another large successful independ-

ent retailer has increased its membership dramatically over the last few

years, as can be seen in Table 1:

Table 1

Year

(as at April each year) No of votes No of candidates No of members % voting

May 1998 480 8 67,574 0.73%

May 1999 564 9 100,000 0.56%

May 2000 424 6 114,281 0.37%

May 2001 1239 9 125,787 0.98%May 2002 1132 8 136,419 0.83%

May 2003 n.a. 8 142,948

However increasing the percentage of active voting members

has been more difficult, but again considerable progress has beenmade. The dramatic improvement in percentage voting in 2001 is

due to a change in the system making it easier to vote: they allowed

members to vote using their dividend card rather than share account

book. Voting is over 4 days and votes can be cast in all 66 outlets.However there is no postal, phone or internet voting although they

are constantly looking at different methods.

The National Trust is the UKs largest membership-based char-

ity, with about 2.7 million members. In 2001, about 90,000 people

voted in the AGM (representing 3.3% of members, some 1800

attended the meeting). Members elected half the board (26 seats)

while the other half (26 seats) were appointed from kindred bodies.

A recent study of credit unions in Ireland shows an average of

2%

of members attending and voting at AGMs (McKillop et al. 2002).This applied regardless of size, but relative to co-operative retail

societies the credit unions are much smaller (with an average of

about 4100 members in 1998).

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Again, looking at evidence from other countries, in one of the

most comprehensive studies of participation in co-operatives and

other associative structures in a single country, Pestoff (1991) findsthat Swedish consumer co-operatives demonstrate the lowest level of

membership activity of any of the 17 types of . . . Swedish voluntary

associations. In 1980 this ranged from 29.2% participating in AGMsof smaller co-operatives to 7.2% participating in AGMs of citywide co-

operatives, to 5.9% in regional co-operatives, and 3.3% in (larger)

metropolitan co-operatives. The author explains this through a struc-tural model of participation, which emphasises the options open to

members to participate in a particular organisation he found that

the greater the contact surface between an organisation and itsmembers (i.e. opportunities to participate), the greater their partici-

pation. (Pestoff 1991).

Size/age effects on participation

There is a common perception that with increasing size and age,active membership and democracy will decline or degenerate. This

can be seen in Figure 3 showing voting in the elections of consumer

co-operatives in the UK in the middle of last century (from Banks and

Mears 1984).

Here the 1933 series shows declining membership democracy

(measured by percentage voting in AGM). This declines with the size

of the co-operative from 5% for large co-operatives to just over 1.5% forsmall co-operatives. The second series shows the effects of age, just over

20 years later democracy has declined in all size ranges of co-operatives

(but least in the smallest co-operatives) with a range of 3.51.5%.

0.00

1.00

2.00

3.00

4.00

5.00

6.00

1,000

and less

1,001

10,000

10,001

50,000

Over

50,000

Size (number of members)

%V

otingatAGM

1933

1954

Figure 3 Voting and size


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However, more recent data from the latter half of the twentiethcentury shows fluctuations in membership. Figure 4 (Co-operative

Union1 197687) shows reducing numbers of co-operative societies(due to competition/failures and mergers), with increasing total turn-

over, and membership declining, as the number of societies goes down

and the size of societies goes up (a clear size effect).

Figure 5 (Co-operative Union 19902001) shows some very

interesting developments indicating that the process of degeneration

can be reversed thereby challenging the inevitability of the degen-

eration thesis. Despite declining numbers of societies and increasingturnover which taken together indicate greater size of co-operatives,membership increases, keeping pace with turnover (and inflation

effects may strengthen this trend).

Coalition formation

Non-transferable ownership shares in DMOs are usually estab-

lished on the principle of one person one vote (rather than one vote

0

5

10

15

20

25

1976

1978

1980

1982

1984

Retail Turnover

1000m.

No. Societies*10

No Members(million)

Figure 4 Retail societies in the 1970s/80s

1 The Co-operative Union now operates under the name: Co-operatives UK.

Retail Co-ops in 90s

0

5

10

15

1990

1992

1994

1996

1998

2000

Year

Turnover/Societies/

Members

Turnover

Number ofSocieties

Number ofMembers

Figure 5 Retail co-ops in the 1990s

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per share). Hence their ownership is widely dispersed, which prevents

a concentration of ownership, and hence inhibits transfers of owner-

ship through mergers, conversions and takeovers. Proxy votes, wheremembers can temporarily assign their vote to another person, might

moderate this tendency, but in practice proxy votes are overwhelm-

ingly given to the chairperson, thereby increasing the power of themanagerial elite (which usually includes the chair).

Hence, the formation of a group or coalition of shareholder

members is difficult, since coalition formation is restricted due tothe non-transferability of control rights (via shares), poor information

about such coalitions, and the practical difficulties of forming a coali-

tion and reaching agreements (particularly with size and dispersedmembership). Thus there are no voting blocks like that of institu-

tional investors in conventional shareholding companies, to exert

concentrated influence, and provide checks on managerial power or

ineffectual boards.

Board functionality

This section considers the implications of the above factors for

the effective functioning of the board. Low participation reduces thelegitimacy of (and trust in) representatives on boards. Issues ofrepre-

sentativenessof the 15% that do elect the board must also be raised,

since they are often dominated by people from the same social or

cultural group, having higher incomes, better education, and being

members of community elites (thereby further reducing trust and

legitimacy). Evidence for this is provided in the Co-operative Commis-sion Report (2001) stated: our concern was that the current minority

was not necessarily representative for instance in age structure of

either the membership as a whole or of the consumer population atlarge. Further evidence is provided in research conducted for the Co-

operative Group (reported in Co-operative College 2003): the research

differentiates between cradle co-operators, older more working class,

who have been brought up to believe in the co-op as a way of life vs

convert co-operators, younger, more middle class, who come to theco-op because they empathise with its values. The study hypothesised

that the latter are more likely in future to become active members and

elected directors. Although as argued in the Co-operative CommissionReport (2001): it must be emphasised that Board members, once

elected are not delegates representing any particular constituency,rather they serve on the Board to oversee the competitive and com-

mercial success of the Society as a whole.


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In addition participation levels can be improved factors influ-

encing the level of member participation include the extent to which

membership strategies deliver benefits, involvement and participationopportunities (see Spear 2000b); and technology has played a part for

many years: Ostergaard and Halsey (1965) reported how postal voting

made a big difference in the 1950s, while Lincoln has shown howsmart dividend cards dramatically effected voting, and it would seem

likely that the variety of channels being considered (mobile phones to

internet) can only increase voting levels.

From the perspective of board functionality (see Cornforth

2002) it may well be that many of the societies examined above can

draw on a substantial pool of active members for their boards, andthis may be satisfactory from the perspective of the level and range of

skills required to function satisfactorily as a board. Nonetheless any

claims to represent the interests (or even know the interests) of the

wider body of members and customers must be called into question

and this may affect the legitimacy of the board in the eyes of mem-bers/customers and other stakeholders.

On the other hand the extent to which board seats are contested

will increase members real choice in voting, and will increase the

legitimacy of a board. Evidence from Irish credit unions (McKillop et al.2002) shows some variation in the extent of contested elections by size ofsociety with 32.9% of the large societies having contested elections,

18.2% of medium societies, and 9.7% of small societies; (N.B. in small

societies there was a high incidence of fewer candidates than posts (28.5%);

this size effect is encouraging for the legitimacy (and democracy) of

larger societies, but traditional practices also play a role thus for

example in UK building societies seats are frequently uncontested.

Summary: the logic of the co-operative/mutual form is that

consumers/users have membership rights, but as we have seen thisis compromised by the lack of an identity principle. In addition fre-quently there is a very low level of participation by members through

the governance structures of annual meetings of consumer/user co-operative and mutual societies recent data shows that most consu-

mer co-operatives only have about 15% of members voting in the

AGM. This may be due to a variety of reasons including opportunities

to participate, and the well known paradox of voting (i.e. it is not

rational for an individual to vote since in most cases one vote will

not make a difference, and the payoff is minimal), and the cost/effort

of getting information, etc to inform voting decisions. This iscompounded by difficulties associated with identifying, forming and

joining a coalition.

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This leads to the conclusion that the vast majority of members

(and even more consumer/users) have no influence on the board and

consequently on management. The impact of this on board function-ality raises issues of representativeness and legitimacy, which may be

counterbalanced to a certain degree by the extent of contested elections.

3.2 Boards and managers

In this section principal agency theory is used to structure

an examination of the extent of members influence in the board/manager relationship. It is argued that managers areeven more powerful

in member-based organisations than in commercial shareholderorganisations.

The main features of the relationship between the principal and

the agent are that the agent may engage in shirking or opportunistic

behaviour unless the principal can select and control an effective

board of directors (examined in the previous section), and design a

reward structure (e.g. promotion, disciplinary action, pay linked to

share value), and gain access to relevant information though underconditions of asymmetric information i.e. the principal can only par-

tially monitor the agents activities. A further control is exertedthrough the market for corporate control i.e. take-overs, the threat of

which keeps managers more responsive to shareholders. There are

other external factors: legislation and regulatory frameworks which

protect shareholders/members interests, and professionalisationfac-

tors which will be examined in the next section. The board governance

factors will be examined in more depth under the following headings:

- reward structure (including goals and measures)

- information and monitoring

Then the external factors will be addressed in the subsequent

section.

Reward structure (goals and measures)

In Principal/Agency theory applied to democratic member basedorganisations, as we have argued earlier, the principal is the member

(who has ownership/property rights over the enterprise). Although

members own the reserves of their organisations, their shares are

not publicly tradable and are not regularly revalued; most memberswill not have a direct interest in profitability, and since their primary

role is not as investors, it is likely that return on capital will not be themost likely payoff to be given priority. Lower prices or better quality


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(consumers), higher wages or better conditions (workers), etc are

likely to be more important. Indeed there may be a discord here

between conventional measures of performance (profit or growth)which a manager might be trained to optimise, and those linked to

member stakeholders.

The board of directors of DMOs, besides having the typical goals

of giving direction to the enterprise, frequently has an official goal of

encouraging the participation of other members see for example

Co-operative Commission recommendations (2001). However as theevidence in the previous section indicates, these goals may not be

operative or effective.

Most DMOs adopt the constraint of a limited return on share-

holding. There is also a tendency not to revalue shares in line with

inflation and business performance. Instead there may be an empha-sis on lower prices and better products, to support the trust relation-

ship between the organisation and the members. Partly as a result of

this and the social goals of co-operatives, the goals and measures of

performance of the enterprise may well be more complex and more

numerous than conventional firms. There are also pressures from

non-voting but influential stakeholders like banks whose financial

interests (via loans) are less likely to coincide with those of memberbased enterprise not seeking to maximise profit. There may bedebates and conflicts over the quality and range of services provided,

and the extent to which conventional strategies like growth (size) of

the enterprise may limit the trust relationship. This pluralism of goals

can result in a lack of strategic focus and greater transaction costs

prioritising them at board level. And an important consequence of

these factors will be greater difficulty in designing effective incentivesystems than for conventional for-profits firms (which have clear

profit/growth related goals and associated measures and incentive

structures). This may have implications in terms of a reduced levelof motivation of managers, but this needs to be balanced against

ideological commitment to the DMO, by managers sympathetic to

the members goals and the co-operative ethos.

Information and monitoring

Due to multiple goals and lack of clarity or consensus about

measures of performance, it will be more difficult for the board to

gather information and monitor performance effectively. In additionboards may exercise insufficient monitoring and control due to littleor no financial stake in the enterprise (nor the possibility of selling

their stake in the enterprise for a good profit on leaving). Members

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may adopt a more limited economistic perspective participating in

customer benefits (such as dividends) without participating in

monitoring and control.

Finally, despite information being essential for control, over

time members may slip into a trusting cosy relationships with the

organisation, its board and managers. They consequently regard

active monitoring and control as less necessary; and as a result inform-

ation may be made available to them rather than distributed; the

implication being that greater effort is required of members forproper monitoring.

There has been frequent concern about increasing businesscomplexity and the possible lack of expertise of board members in

DMOs. Non-executive directors (co-opted from outside the organisa-

tion) can play an important monitoring role here but they are notalways acceptable for example they have been opposed in the UK

consumer co-operative sector (see a major report on co-operative

corporate governance, Co-op Union 1995).

3.3 External factors influencing governance

There are a number of wider institutional factors that also havean important bearing on member influence in DMOs, and correcting

or avoiding situations of weak governance/management and poor

organisational performance.

Market for corporate control

The market for corporate control mergers and acquisitions is

regarded as an important institutional mechanism for waking up sleepy

managers and cosy board relations. The lack of institutional investors,

difficulties forming coalitions, and the dispersed influence of members,

(which is exacerbated with increasing size) thereby weakens this formof external control. Thus mergers are generally agreed and manager-

led (though many may be forced as a last resort) rather than hostile

takeovers. The large numbers of small and medium UK buildingsocieties (savings and loans organisations) and health insurance

friendly societies (mutuals) testifies to this tendency, in a financial

services sector which has seen major consolidations.

Legislation and (self) regulation

Legislation and regulatory institutions set the frameworkswithin which the market for corporate control can operate; it also


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sets standards and expectations about good practice in governance, for

example several reports have been produced on governance in the

private business sector: the Cadbury Report on the Financial Aspectsof Corporate Governance (1992), Greenbury Report on Directors

Remuneration (1995), the Hampel Report (1998), Department of Trade

and Industry Review of the role and effectiveness of non-executivedirectors (2003). These reports have been mirrored in parts of the

social economy, thus for example the Co-operative Union which has

taken account of the above reports and revised its Corporate Govern-ance Code of Best Practice for retail societies frequently over the

years, including in 1995, 1998, 1999, 2000, and 2001. Indeed, this

federal body now known as Co-operatives UK has frequently playedan important self-regulatory role in reforming governance in mem-

bers interests.

Changes to legislative frameworks also have unintended conse-

quences, thus the UK Building Societies Act 1986 which deregulated

the sector allowing more flexible operation for competition with banks(and facilitating conversion to limited company status) led to a far

greater number of demutualisations of these financial mutuals, than

had been anticipated. However, this in turn did much to awakenmany of the remaining mutuals to their distinctive differences and

their unique member orientation, leading to a regeneration of mem-

ber oriented activities for involvement and participation amongst

many of the remaining financial mutuals.

Professionalisation and labour markets

Fama (1980) argues that the existence of an active managerial

labour market serves to motivate good management. In such a con-

text, institutional and professionalisation factors become important.

This helps construct the values and attitudes of professional man-agers; and institutional factors such as education/training increase

the pressures towards isomorphic corporate governance behaviour(where training is dominated by mainstream practices) resulting

in similar patterns of governance in non-profit/mutual/co-operative

and conventional corporate sectors. An active labour market can

have a similar degenerative effect on the distinctive values and prac-

tices of DMOs. However where labour markets are segmented alongDMO lines, and as training and business school education become

more differentiated and serve a social economy labour market, there

is the possibility of countering such degenerative isomorphic tenden-cies. A similar function can be achieved through internal manage-

ment development oriented to the specificity of the social economy

48 R. SPEAR

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sector see for example a report on such a programme in the UK

consumer co-op sector (Watkins and Bickle 2000).

Summary: The result of lack of coalition formation, low member partici-pation, and insufficient board control results in weak stakeholder (mem-

ber) control, which is exacerbated by the absence of external control

through the market in corporate control (as argued above) and the gen-eral weakness of legislation in protecting member rights, though this

varies country by country (see Monzon Campos et al. (1996) for a review).

The consequence of this is that the agents (managers) have

more freedom of action than in conventional enterprises and will

not be under pressure to perform according to member interests. In

the many cases where there is good management, oriented towards

member/consumers, this is unlikely to create performance problems.

But poor managers may exploit this situation with less effort, lessconflict, and more remuneration. This weakness in turn weakens the

original market advantage of such enterprises in trust and collectivegoods, by reducing trust and reducing the incentives and controls for

good performance. In the worst case the result is sleepy managers,

cosy board relations and poorly performing social enterprises that eat

into its asset base, often accumulated over generations, until it is takenover or fails, as markets become more competitive. Poor governance

systems have clearly played a part in the general decline in consumerco-operatives during last century (Brazda and Schediwy 1989).

This situation relative to the private sector should not be over-

stated (since many argue that shareholder control is weak e.g. Berleand Means 1932), but institutional investors play the most important

role in balancing manager power in the private sector, and they playno role in most DMOs.

However conclusions from this analysis also have implicationsfor the design of governance systems. Use of the control perspective(P-A theory) emphasises the importance of finding ways to reward

and support good managers/boards, but it also reveals the issue of how

to rejuvenate poorly performing social enterprise. An active member-

ship can provide a crucial countermeasure to poorly performing social

enterprise; but that is unlikely to be sufficient, and countervailing

measures will also need to be developed (see Section 5).

Limits of control perspective

P-A theory suffers from a similar critique to that of rational

choice theory which is based on similar assumptions (see Abell 1992).


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For example that of individualism (it is only individuals that

ultimately take action), and optimality (individual actions are opti-

mally chosen), and self-regard (provisionally individuals utility func-tions and actions are entirely concerned with their own welfare). Such

an individualistic approach does not exclude collective, social or

organisational factors, but it does tend to ignore them or play themdown.

P-A also faces more specific criticisms that have a particular

bearing on DMOs:

- it privileges property rights, neglecting the claims (and power)

of other stakeholders- it privileges financial considerations (but equity based ones

rather than loans from banks clearly an Anglo-Saxon

business bias), and- it tends to ignore non-financial motivations such as mutual,

reciprocal social benefits, trust, and other features of social

economy ideology that often helped initiate and support such

enterprises.

Thus while P-A informs a control perspective, it is not the whole

story when analysing governance systems, since it is also important to

develop a perspective that reflects the importance of developing adynamic of high trust (together with loyalty and ideological commit-ment). This brings the best out of relations between stakeholders in

the social enterprise, particularly between members, directors and

managers. As well as ensuring that an appropriate balance is achievedso performance and trust do not degenerate over time (Cornforth

et al., 1988). This leads to the important consideration of collaborative

dimensions in the design of good governance systems.

4 Trustee model of governance a collaborative philosophy?

In this section we develop a collaborative perspective on govern-ance systems for DMOs, based on a normative model developed by

Kay and Silberston (1995), which can be used to inform good practice

of managers and boards of DMOs. Kay and Silberston (1995) developan implied critique of P-A theory by proposing a model that, they

argue, fits more closely to reality. They base their critique firstly on

the empirical evidence that shareholders do not in fact control com-panies, as researchers from Berle and Means (1933) onwards have

argued. They also challenge the property rights basis of the claim for

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control. They argue that the property rights given to shareholders are

extremely limited, compared with a common sense view of ownership.

For example ownership of a house, gives rights to:

- access;

- use of premises or assets;

- exclude non-owners;

- participate in decisions (particularly about disposal of, and

purchase of, assets);

- share in the costs/proceeds of asset sales/purchases.

They draw on the work of Grossman and Hart (1986) who argue

(in the context of viewing the firm as a nexus of contracts) that theowner is that person who enjoys rights over it that have not been

given to others by explicit contract (residual contract rights). They

give the example of a hired car which is clearly owned by the hirer,but the contractee enjoys rights normally associated with ownership.

If one applies this model to the firm it is the managers that appear to

own it, but clearly they do not legally. This leads to argument that

ownership may not be the most important factor in the control of the

firm (particularly as its rights are clearly weak); and that other

stakeholders (notably banks and employees) also have a right for

their interests to be taken into account, and to exert influence tothat effect. In the 1985 Companies Act in the UK the right of share-holders to exclusive claim of the residual assets in case of liquidation

was reversed, and directors were given an explicit duty to strike a

balance between employees interests and others.

Kay and Silberston identify two clearly different models of

governance. One is based on the idea of concern for shareholder

value, which is prominent in the Anglo-Saxon (USA and UK) contexts,

partly because of a particular economic theory, and partly because of

the threat of hostile takeovers (the importance of the market forcorporate control). (P-A theory fits well with this model). The secondmodel draws on Japanese, German and non-profit contexts it is the

trustee model.

In this model (similar to the stewardship model Davis et al.

1997) the managers of the enterprise have the duty of preserving and

enhancing the value of the assets under their control, and of balancingfairly the various claims to the returns on those assets. The idea of

a professional approach (like that of a doctor), and the view of the firm

as a social organisation and a community are discussed in relation tothis view). The two fundamental differences from the P-A model are

as follows:


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- the trustees responsibility is to sustain the corporations

assets rather than the value of its shares; this represents a

broader responsibility than financial interests since assetsinclude skills, customer/supplier expectations (deriving from

long-term trust relations), and reputation in the community.

- rather than giving priority to a single shareholders interests,in the trustee model, the managers have to balance a diverse

group of existing stakeholder interests (sometimes conflict-

ing), and weigh the interests of present and future stake-holders.

The effect of this is to impose a longer term view of the develop-

ment of the enterprise on the managers. This model thereby alsoimplied reduced importance for the non-executive director role (rather

than shareholder representative and protector). Kay and Silberston do

however acknowledge two problems associated with this view. First the

problem of resolving, and prioritising a multiplicity of goals, and meas-

uring performance against them (rather than the focus arising from thesharp clear goal of shareholder value); and second the problem of

coherence in a management team vs diversity reflecting the different

stakeholders. The authors acknowledge the importance of coherence,but stress management should be held accountable). Part of the way of

strengthening the effectiveness of their model is through legislative

support in their proposed revised companies act.

If this model is applied to democratic member owned organisa-

tions, it is clearly more attractive from the point of view of emphasising

the social dimension of DMOs, where trust2 and social economy values

can be functional for good performance and good board/manager/

member relations. Most DMOs would recognise the importance ofconsidering the interests of all stakeholders, but they would expect

some privileging of member interests.

2 Some refinements may be developed about how loyalty and trust may

be related to contingent environmental factors such as social embeddedness;

for example a study of 900 US savings and loans agencies (SLAs the

equivalent of UK building societies) founded between 1960 and 1987, was

concerned with comparing the effects of different governance arrangements

and capital structures arising out of different ownership structures

comparing mutual and joint stock SLAs. This study concluded by indicatingfuture lines of research, hypothesising that the conditions favouring mutual

development and survival might be those where members were fairly densely

populated in relatively stable communities (Rao and Neilsen 1992).

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Limits of the collaborative trustee model The model has many

virtues, but also a number of weaknesses. It seems to underestimate

the importance of checks and balances on managerial power (and itseffect on their motivation). In both the Japanese and German models,

on which the trustee model is based, banks and (cross-linked share-

holdings) have a powerful role to play in this respect. It also seems torest heavily on the professionalisation of managers, and legislative

support, neither of which may necessarily take place to the extent

required.

From a theoretical perspective it ignores (largely) an area

related to P-A theory transaction cost theory, which is also based

on a contracts view of the firm, but emphasises the importance oftrust and core skills. Indeed it may be that a strong emphasis on trust,

asset specificity and core skills may lead to measures of performance

relevant to the operation of this model. A further theoretical point of

criticism is that although in critiquing the P-A model and its rele-

vance to the UK/US context (and likewise for the trustee model andJapan/Germany). It fails to fully acknowledge that this may represent

a contingency view of governance based on economic or other relevant

theory, and the context (e.g. the extent of a market in corporatecontrol, or extent of social embeddedness) may be particularly import-

ant. The import of this is both the issue of appropriateness to context

and that of how a dominant model of governance becomes established

in that context (institutional theory may have an important role in

elucidating this issue). However the general thrust of this papers

argument has been that in the design of good governance systems(for DMOs), it is not a case of either a P-A inspired control model or a

trustee inspired collaborative model, but a balance between thetwo albeit that this balance may be different in different institu-

tional contexts.3

3 However it may be that the tendencies and propositions emerging from

the above analysis provide a line of research and a basis for evaluating the

dynamics of governance by examining the wider institutional context and how

factors of social embeddedness, ideology, and power are played out.

Institutional theory may, in these respects, help explain dominant modesof governance arising from typical resolutions of these competing forces

(e.g. deriving from managerial professionalisation and other institutional

factors).


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5 Countervailing measures on managerial power

Here the perspective shifts to a wider institutional focus forachieving a well balanced and well functioning framework for govern-

ance systems for a DMO sector. A number of institutional measures

are emerging to provide checks and balances on managerial power inDMOs, and enhance the trust/collaborative dynamic. These include

corporate governance codes which are strengthening boards, improve-

ments to level of democratic activity by promoting membership and

different types of membership activity (e.g. through membership

groups), social audit as a way of making managers more visibly

accountable, corporate social responsibility measures, and forumwhich link members and managers directly. Many of these measures

have been taken up (and even developed) in the more progressiveco-operative societies. Other measures have been discussed in the

UK co-operative movement such as use of non-executive directors

from a central register of sympathetic experts, but so far have not

been taken up.

This paper has argued that managers may be more insulated

from pressures to perform, and be more insulated from stakeholders

than in private business. This places greater emphasis on counter-vailing measures that will develop good practice in the boards, keep

managers focused, and develop ways of being responsive to stake-holders. Such countervailing measures include:

- Regulation or voluntary self-regulation to improve govern-ance standards such as establishing and using codes of

practice, benchmarking appropriate performance indicators

(such as % customers who are members, % members voting,% elections contested, etc).

- Lively, competent boards this can be achieved throughincreasing member participation and training of board

members and active members; developing a clear remit for

board members, and possibly recruiting non-executive board

members; establishing ladders of governance opportunitiesfor members to become more active and develop skills also

becomes important.- Good professional manager development in particular

awareness of, and development of corporate social respon-

sibility (CSR), since good CSR practices should be expected

in co-operatives; so that acting as a professional managerrequires a responsible attitude to boards and the governance

function.

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- Effective incentive structures for managers; this means

ensuring the remuneration package is adequate, matches

comparable positions in similar managerial labour markets,and is linked to measures of performance that match the

aspirations of the co-operative and its members and stake-

holders.- Better reporting (such as social audit) to ensure an informa-

tion system provides well founded measures of performance

so that managers can appropriately target their activities.- Stakeholder dialogue to enhance trust dynamics and ensure

that aside from measuring performance relating to stake-

holders (via social audits and managerial information systems),there are processes and channels in place for ensuring commu-

nication with key stakeholders (especially staff) so that good

partnerships can be established.

6 Conclusions

This paper has argued that members only weakly influenceboards and hence managers. That the low level of membership activ-

ity in consumer/user co-operatives and mutuals raises questions aboutthe extent to which board members may be considered representative,and the extent to which the democratic process gives a mandate to the

elected board. It argues that managers in consumer/user co-operatives

and mutuals have more power than in similar private sector organisa-

tions, and that the market for external control is weaker.

The consequences are that managers may be more insulated

from pressures to perform and be more insulated from stakeholders

than in private business. With good management, performance will

not be an issue, the main risk will be if they are succeeded by weakermanagers, and this begins a decline. In the worst case the result

will be sleepy managers, cosy board relations and poorly performingdemocratic member-based organisations.

The analysis has pointed towards a series of institutional coun-

tervailing measures that have been informed partly by the controlperspective and partly by a collaborative, trustee perspective that

emphasises the importance of being responsive to stakeholders. The

combination of these two perspectives together with the countervail-

ing measures helps to ensure a balanced governance system, whichcombines high-trust relations with checks and balances on managerial

power, so that good social and economic performance of the organisa-tion is achieved.


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Gouvernance democratique dans les organisations basees sur les

membres

Larticle traite des aspects de la gouvernance dans des organisationsdemocratiques basees sur les membres, comme les cooperatives et les

mutuelles. Il examine les voies par lesquelles les interets des membressont pris en compte via le processus democratique et la direction. Il

analyse certains des facteurs qui affectent le pouvoir des gestionnaires.

Lauteur demontre ensuite que le systeme de gouvernance dans ces

organisations presente le risque de rendre des managers puissants et

isoles amoins dadopter des mesures compensatoires.

Demokratische Governance in Organisationen, die auf ihren

Mitgliedern basieren

Dieser Beitrag befasst sich mit Problemen der Governance in demok-

ratisch verfassten Organisationen, die auf ihren Mitgliedern basieren(democratic member based organisations DMOs), wie etwa Genos-

senschaften und mutualistischen Gesellschaften. Untersucht werdendie Prozesse zur Mediation der Mitgliederinteressen durch den demok-ratischen Prozess und den Vorstand, und es werden einige der Fakto-

ren untersucht, die die Macht der Manager beeinflussen. Es geht dann

weiter mit der Feststellung, dass das Governance-System in DMOs

und ihrem Umfeld das Risiko beinhaltet, dass die Manager machtig

werden und sich isolieren, wenn nicht Gegenmanahmen ergriffenwerden.

Gobierno democratico en las organizaciones basadas en sus

miembros

El artculo trata los aspectos relativos al gobierno en las organiza-

ciones democraticas basadas en sus miembros, tales como las coopera-

tivas y las mutualidades. En el se examinan los procesos a traves de los

cuales se toman en consideracion los intereses de los miembros por lava democratica y de la direccion. Analiza, asimismo, algunos factores

que afectan al poder de los gestores. El autor demuestra, a continu-acion, que el sistema de gobierno en estas organizaciones presenta el

riesgo de convertir a los directivos en poderosos y aislados, a menosque se adopten medidas compensatorias.


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