In the last decades, important transformations have been occurring in how mangers or organisations accommodate new technological changes, with the emergence and global expansion of new phenomena such as digital technology diffusion and digital innovation. These technology-enabled developments open many opportunities for companies and entrepreneurs.
They also present several key challenges for governance of both inter-organisational collaborations and the organisational mechanisms to control creation, retention and distribution of knowledge and value. Yet very little is known about how digitally enabled transformations may affect the effectiveness of corporate governance including its objectives, scope and processes.
Effective corporate governance
Academic research suggests that effective corporate governance employs mechanisms to ensure executives respect the rights and interests of company stakeholders, as well as making those stakeholders accountable for acting responsibly in the generation, protection, and distribution of wealth invested in the firm (Aguilera, Filatotchev, Jackson and Gospel, 2008).
The effectiveness of corporate governance mechanisms has been associated with a number of different dimensions, ranging from monitoring and control over a wide range of managerial decisions to promoting strategic leadership and longer-term strategic orientation.
More recently, sociology-grounded research has associated “good governance” with practices that are generally regarded to be necessary to achieve legitimacy of the firm which, in turn, impacts its long-term sustainability in the highly uncertain market and institutional environments.
Underpinning corporate governance are also various policy approaches that aim to improve the effectiveness of corporate governance by strengthening corporate boards and empowering company investors and other stakeholders. However, these traditional views on the effectiveness of various governance mechanisms need to be revisited bearing in mind the dramatic challenges associated with digital transformation.
What is digital transformation?
There are numerous digital technologies and even more ways to classifying them in commercial jargon. Technology firms such as Cisco, Fujitsu and Intel are promoting digital technology agenda from the technology capability side. Beyond the commercial jargon, we can capture the capabilities that digital technologies bring about with a relatively simple formula:
| Capabilities = Digitisation x Connectivity x Data x Automation x Many more to come (eg, 3D printing, augmented and virtual reality, etc.) |
- Pervasive digitisation: the first capability that we need to understand is digitisation. Everything in the modern world has been touched by digital technology, and digitisation is becoming very pervasive.
- Pervasive connectivity: digital technologies have created bridges across stakeholders, from the product, to businesses, to the consumer, and across once disconnected knowledge domains. Our phones, computers, appliances and lifestyles are all inter-connected. This connectivity will only increase in the coming years, and by 2030, 80% of the population will be connected by smartphones. “Things” will become linked through billions of connectors and trillions of sensors as society becomes more socially and economically mobile.
- Big data: as a result of digitisation and connectivity various businesses and organisations have access to a plethora of data. Information is not only accessible but there is an ability to collect and store data at an unprecedented scale. The connections of the digital world have also lead to a growth in qualitative data, giving companies more insight and information about consumers and their spending habits, as well as information about how machines operate.
- Efficient automation: conceptually, automation today is not different from the previous waves of automation that were introduced starting from the industrial revolution. However, what is now significantly different is the pervasiveness and scope of applicability of the ongoing automation dynamics and growing applications of artificial intelligence. Due to increased computing power and wide data availability, algorithms have become faster and more nuanced, as machines are now able to learn automatically. Today, terabytes of data about consumers are communicated daily as algorithms become smarter and more efficient.
While these technology capabilities are not entirely new or unexpected, it is their full pervasiveness, interoperability and exponential pace of development that makes the scope and scale of digital transformation difficult to understand on the basis of the traditional views on corporate governance. Furthermore, digital transformations create a massive possibility for innovation by recombining the basic technological capabilities. The scope of these digital innovations is near to impossible to predict and nail down.
Digital transformation and board effectiveness
To begin with, digital transformation has had a profound impact on the governance processes. For example, board meetings in various organisations are increasingly conducted online, and share registers containing details of share owners and their equity stakes are kept electronically. Companies increasingly use digital platforms in their communications with broader groups of stakeholders. Apart from affecting corporate governance processes, however, digital transformation has started challenging the key aspects of board effectiveness.
Greater monitoring capabilities
Digital technologies may be well positioned to equip directors with enhanced – perhaps, technically more efficient – monitoring capabilities thus potentially reducing performance volatility. However, this is increasingly considered as an optimistic (or reductionist) view of digital technologies, and the business press is full of examples of serious misconducts even in companies using sophisticated digital monitoring systems (for instance, UBS’s rogue trader or the UK Libor fixing scandals).
New risks
At the same time, academic studies are highlighting that, far from eliminating risks, digital technologies compound risks of the traditional information systems – eg, an implementation risk – with specific new ones. For instance, automated monitoring via digital technologies is based on algorithms that, no matter how sophisticated they may be, are path-dependent and derive their learning from elaborating on past data and information.
Furthermore, the algorithms themselves might be biased, and digital technologies may enact biased monitoring. This is even more worrying if we consider that digital transformation is also abruptly changing competitive mechanisms and key success factors. Digitally enabled monitoring systems might simply be monitoring past, and increasingly irrelevant, KPIs. For instance, in the past companies often had strategic objectives aimed at generating thousands of new customers in as few segments as possible. A monitoring system geared towards these legacy KPIs may be at odds with the current need of tailoring the firm’s value proposition to fewer customers, yet in more market segments, which is a common strategy in the era of digitalisation and personalisation.
Overall, while digital technologies might make board oversight skewed towards a focus on increasingly obsolete strategic priorities, they are also likely to give boards a false sense of security since digital monitoring may seem to be effective.
Changes to boards’ strategic roles
The strategic role of corporate boards may also be at a crossroads. The combined effect of digital technology diffusion and digital innovations tends to undermine any legacy advantages and exposes companies to high risk of disruption. Lanzolla and Giudici (2017) identify several strategic trade-offs that companies will have to grapple with during digital transformation – eg, optimisation vs. slack; efficiency vs. differentiation; knowledge specialisation vs. knowledge integration; relations vs. products; open vs. closed.
In dealing with these trade-offs, management will have to make choices that address the fundamental core of a company’s vision, mission, values and assets. Boards are therefore likely to be asked more frequently to provide strategic guidance/strategy scrutiny. Intelligent computational algorithms powered by big data and analytics have great potential to augment a board’s foresight.
However, current boards are often not fully equipped with the knowledge integration capabilities required to deal with digital transformation. The current trend towards bringing external consultants to advise on digital transformation is likely to amplify this problem by diffusing accountability and reducing even more the potential for knowledge integration. Overall, the traditional board strategy role is likely to be augmented, yet the existing governance policies and practices do not seem to be conducive to this transformation.
Regulation lags behind new markets
Digital transformation is creating new markets which often emerge in a regulatory vacuum. Managers enter such markets to seize a business opportunity but also hoping to create a prevailing “institutional logic” which sets the rule of the game. In the pursuit of economic efficiency, managers may push companies to adopt development strategies which may not be acceptable by society.
Examples include the spread of “fake news” through social platforms, breaches of privacy and growing concerns about cyber security. Again, the traditional governance principles focused on maximising shareholder value may make boards ill-equipped to deal with social and institutional challenges that their companies will incur when delivering on digital transformation.
Improving board effectiveness
Improving board effectiveness in the context of digital transformation will entail a systematic redevelopment of governance policies associated with board mechanisms and director skills. In the short term one of the key, most pressing, issues is related to the new dimensions of board diversity, going beyond gender, age and traditional legacy knowledge domains.
For instance, while knowledge about cyber security has improved in many boards, even more “resident” cyber-security knowledge – and not outsourced to a consultant – is required. Crucially, boards should equip themselves with more knowledge integration skills. Perhaps here there is a scope to redefine non-executive directors as boundary spanners to share knowledge and experience between and across sectors.
In the longer term, it is important to recognize new types of strategic and organisational risks that should be considered and managed by boards. These include risk of business disruption, risk of losing organisational legitimacy, business ecosystem risks, relational risks, among many others that digital revolution may create in the near future.
To summarise, digital transformation is not confined to organisational products, processes and business models. It also creates a pressing need for innovations in internal organisational architecture including governance systems. At the end of this transformation, the very scope and mechanisms of corporate boards may be very different from what companies use now.
Further information
If you are concerned with issues covered in this article and would like to learn more about digital transformation and its impact on boards and corporate governance practices, please contact Professor Igor Filatotchev and Professor Gianvito Lanzolla at Cass Business School, City, University of London.
Professor Igor Filatotchev and Professor Gianvito Lanzolla, Cass Business School, City, University of London
Corporate Governance Group, March 2017
© Cass Business School 2017
References
Aguilera, R. A., Filatotchev, I., Gospel, H., Jackson, G. 2008. An organizational approach to comparative corporate governance: Costs, contingencies, and complementarities. Organization Science, 19: 475-492.
Lanzolla, G. and Giudici, A. 2017. Pioneering strategies in the digital world. Business History, forthcoming.
