The importance of good corporate governance has received a renewed vigor over the last decade, culminating recently with the impact of the COVID-19 pandemic. Companies now, more than ever before, need to be more resilient and sustainable. Our recent paper explores the shortcomings of corporate governance and how AI may provide tools to address some of these embedded problems.
The use of Artificial Intelligence (AI) has the capacity to be revolutionary and change even the most basic of task, for example, “Alexa turn on my office light.” The increased use of basic AI systems appears to have become commonplace with use of in-home assistants doubling over recent years. Two questions in the context of corporate law arise from this evolution: first, what part could AI play in corporate governance and second, what purpose or need is there for it in the corporate context. Our paper explores both the purpose and opportunities of AI in the boardroom.
Corporate Governance Problems.
Understanding the reasons why AI might be beneficial in corporate governance requires an exploration of governance problems. Our paper presents two problems which AI has the capacity to transform. The first problem identified within the corporate governance landscape is that of embedded short-termism. The second is the focus on the shareholder-centered approach.
The Challenge of Short-termism
Short-termism arises largely due to the separation of ownership and control which has developed even further since its initial discussion by Berle and Means. The increase of institutional investors, such as pension and trust funds, has resulted in further separation of ownership and control with a greater focus on profitability and share price. This has in turn resulted in two deficiencies of corporate governance mechanisms: first, shareholder interest is trivial and as such the individual vote is immaterial, and second, exit is preferred over voice. The overall result is a lack of activism which heightens the risk of self-serving opportunism from corporate managers. This is a problem of corporate governance as it renders the board to consider short-term ends opposed to the longevity of the company. There remains a pressure on directors to deliver returns on investment or shareholders will sell their shares, opening up the risk of a takeover. This pursuit of profit and market price decreases the value or weight of consideration for wider Environmental, Social, and Governance (ESG) factors. This lack of wider stakeholder consideration is detrimental for both the company’s long-term sustainability but also more broadly for social interests. The deep-water horizon oil explosion is an example of the ruthless pursuit of profit resulting in environmental damage and the loss of life.
The Shareholder Centered approach
The concept of ownership and who owns the corporation has been one of the most contested areas of corporate law for over one hundred years. Jensen and Meckling argue that the firm is a collection of agents and actors in which the agents carry out works for their principal. Lynn Stout argued that this focus on the myth of shareholders is detrimental for the long-term interest of the company and as the company is its own legal person, it is incapable of being owned. Despite this the focus remains on shareholder value and maximizing this value as the shareholders are the residual claimants within the corporation. Parkinson argues that there should be a greater consideration as to the social conception of the firm. Irrespective of conflicting corporate theories and ideologies, the widely accepted concept of the company is that of the shareholder-centered approach. This dictates that the corporation exists to serve the shareholders and the company ought to be run in the sole interests of the shareholders. In countries such as the United Kingdom, this approach has made its way into legislation as a requirement for directors to discharge their fiduciary duties. This focus on shareholder returns is one of the key drivers of short-termism and incentives high-risk transactions.
Is AI the solution?
Given the embedded problems within corporate governance, the ability for an innovative approach to tackle such problems could be the solution we have long awaited. There are several ways AI could revolutionize corporate governance. The potential is broken down into a number of categories: incremental/facilitative, radical/disruptive, and fundamental/structural. Incremental/facilitative is the lower level which has been utilized in manufacturing for years. Whereas radical/disruptive is where there is a displacement of human agency. Fundamental/structural is whereby current governance systems are eradicated and replaced by new governance systems. Our paper presents the argument for the incremental/facilitative approach due to the ability to augment the existing skills within the boardroom without a complete overhaul of legislation and corporate frameworks.
The use of facilitative AI is beneficial for several reasons, the first is quite simply that it does not involve significant changes to legislation or company constitutions. The proposal we put forward is that AI can be utilized as a tool in the boardroom. We envisage this tool to be advisory and assisting in board decision making, as opposed to being a member of the board and making independent decisions. The benefits of such a tool is that it augments and does not replace directors or their skill set. Companies and decisions are idiosyncratic in nature and the skills held by human directors are of significant benefit to the company. In utilizing AI as a tool, it builds on an existing skill set thus enhancing board decision making. AI has the capacity to process large data sets quickly and accurately which affords the board a wider remit of data in decision making without the need for radical or structural change such as the displacement of natural person directors. An AI in this regard could prove useful for other board members. An AI can take data and process broader datasets and make recommendations for adoption by the board. As the AI remains supervised by human agents, there is legitimacy to the role of an AI, which is unlikely to be the case where a fully autonomous AI director is operating in the same scenario. The benefit for wider societal interests and ESG is that the assistive AI tool can include stakeholder views in its processing of recommended outputs. To contextualize this by way of an example, stakeholder considerations could amount to 10% of the weighting in the analysis by the AI. The ability to process data and attach different levels of consideration is a unique capability offered by AI solutions, made possible by the ability to objectively add weight to each stakeholder.
Shareholder Democratic Participation
The benefit of AI in the context of democratic participation centers on the idea of reducing asymmetric information and increasing the flow of data between shareholder and corporate managers. This increase in data flow is beneficial because it not only provides a platform for transparency but also allows investors to retain confidence in exercising their rights due to the availability of information. We present the argument that by providing data in an easily accessible and readable format shareholders will be able to exercise their votes in an informed and confident manner. The benefit of this is that shareholders will become greater activists and more engaged with the company. This in turn will reduce short-termism as the previously unheard shareholder voice is being given a platform to be heard.
The second way in which AI can be transformative in assisting decision making is the inclusion of wider stakeholder considerations. We argue that a failure of corporate governance is the focus on the “shareholder-centered” approach. The inclusion of a wider consideration includes more stakeholders. By way of example employees given their internal position are well placed to ensure accountability with corporate managers due to their understanding of the internal functioning of the company. The inclusion of their voice is therefore likely to be valuable to decision making. More broadly, the ability to consider longer term factors, creditors, environment, and the community will bring benefits of a more sustainable and resilient corporation.
One of the key benefits of AI as a tool is that it is facilitative and not a radical or structural change. The result is that there need not be a dramatic overhauling of legislation. This being said, there are ways in which corporate law can facilitate AI and the use of AI to augment the skills of directors’ decision making in the boardroom. We submit two proposals. The first proposal is that the fiduciary duty to exercise independent judgment should be read in the context with AI as a tool. In this regard, where corporate managers have utilized an AI tool to assist in decision making, this will not be found to be a departure from their duty to exercise independent judgment. This links to the second proposal we present, the introduction of “the technology” director. The technology director would be responsible for ensuring the AI tool is maintained and responsible for its data governance. They would be technically qualified in the field of computer science, which would increase their objective and subjective fiduciary duty of care. This increase re-contextualizes the standards of directors, providing further support for the use of AI. The technology director can assume responsibility for data quality for elements such as accuracy and completeness which further legitimizes the use of the AI tool.
Our paper identifies two key problems within corporate governance and considers how AI as a tool could be utilized to reduce the challenges these problems present. These two problems were that of 1) short-termism and 2) the shareholder centered approach to corporate governance. We propose that by augmenting the capabilities of an AI into corporate decision making, the effects of these problems could be mitigated. AI as a tool was proposed as a solution to achieve the goals of both reducing short-termism and departing from the shareholder centered approach. AI can transform corporate governance to be a more inclusive construct, and this is possible with minor reconsiderations to the current legislation and norms. The result will be a greater value for both shareholders and stakeholders in the longer term. AI as a tool can also be conceived as the first step towards AI in the boardroom.
Dr Joseph Lee is a Senior Lecturer at the University of Exeter Law School
Mr Peter Underwood is a Postgraduate Teaching Assistant at the University of Exeter Law School
This post is adapted from their paper, “AI in the boardroom: let the law be in the driving seat,” available on SSRN.