Corporate governance as an institution to overcome social dilemmas

Abstract

During the current international financial crisis, the effectiveness of existing corporate governance institutions has been questioned both in the scientific community and in the media. A special focus of this discussion is on the containment of opportunistic behavior. In the corporate governance literature, the dominant approaches axiomatically assume individuals with self-interest or opportunistic behavior. The modern research stream of psychological economics, however, has shown that prosocial preferences exist and do matter. When the determinants of prosocial behavior are considered, the implications for the design of corporate governance institutions may clash with conventional wisdom. We suggest that the following measures help to overcome social dilemmas at the firm level: board representation of knowledge workers who invest in firm-specific human capital, attenuation of variable pay-for-performance, selection of directors and managers with prosocial preferences, and employee participation in decision-making and control. With our approach, we make a rare attempt to apply psychological economics to a complex institution, namely corporate governance.