The concept of managerial discretion in corporate governance – better off without it?

Introduction

The concept of managerial discretion pertains to several research disciplines. It has been argued that managerial discretion advances corporate governance scholarship. Corporate governance addresses the relationship between the owners (and their representatives, i.e. the board of directors) and the chief executive officers (CEOs). Corporate governance is understood as the system by which companies are directed and controlled (Cadbury, 2000). Additionally, corporate governance can be conceptualised as a set of processes, customs, policies, laws and institutions affecting the way a corporation is directed, administered or controlled (Mostovicz et al., 2011). To Shleifer and Vishny (1997), corporate governance deals with the ways in which suppliers of finance to corporations assure themselves of getting a return on their investment.

Some 30 years ago, the concept of managerial discretion was introduced to explain the relationship between managerial tenure and organisational outcomes with managerial discretion as a moderating variable. Later, the relationship between managerial discretion and organisational performance was investigated. Hambrick and Finkelstein (1987) developed the concept of chief executive discretion and defined it as “latitude of action”. The determinants of discretion were factors in the environment, the organisation and the chief executive’s own attributes. A chief executive who is aware of multiple courses of action that lie within the zone of acceptance of powerful parties is said to have discretion. When used as a moderating variable in corporate governance scholarship, managerial discretion plays the same role as do a number of other contingency factors in management and leadership theories.

Because corporate governance pertains to the relationship between the owners (board of directors) and the CEO, the issue of top managers’ latitude of action emerges. It may be beneficial to the owners to grant top managers a high degree of discretion with respect to greater return of investment. However, by doing so, the corporation may be subject to high risk or opportunistic behaviour by the managers. On the other hand, a low degree of discretion may prevent risky or opportunistic behaviours but may lead to less return on investment. The question addressed here is whether research on managerial discretion provides owners and directors of boards with applicable advice on granting top managers either a high or a low degree of discretion.

This paper scrutinises the concept of managerial...