Why Corporate Governance is important for innovation

You would not normally assume that corporate governance can play an important role in innovation, after all corporate governance is about risk mitigation whilst innovation is all about encouraging risk in order to stimulate new ideas. The two would, therefore, seem to be in conflict with each other. However, this isn’t the case and in fact we believe that having effective and well structured corporate governance processes at every level of a company can play a crucial role in unlocking innovation in all firms from small start-ups through to large international listed companies.

This is our first article in a series on corporate governance, where we will take a deeper look into the role that it can play for all companies. We believe that corporate governance is going to become one of the most important topics over the next decade and that every firm needs to focus on developing good corporate governance systems to not only mitigate risks but to crucially aid in the stimulation of new ideas.

The difficulty with innovation

There is a general recognition that innovation is critical in enabling companies to create advantages over their competition and to thrive in increasingly fast moving times. Yet innovation is, in itself, an expensive, time consuming and risky investment. Innovation can also take many years to reap rewards, so companies must be willing to take on board long-term risks and costs in order to be able to effectively innovate and to bring new products or services to market.

Conflict can also occur between needing to take a long-term approach to innovation versus a short-term approach typically favoured by shareholders and investors in many companies. This leaves many company managers and directors in a difficult position as they need to balance their short-term survival and metrics, which shareholders and investors demand, with a long-term approach that is needed. With this kind of choice it’s not a surprise then that many managers take a risk averse short-term approach to protect their job and to err on the side of caution instead of trying to develop the breakthrough innovation which is really needed.

The struggle of innovation for boards

Boards play a diverse and complex role in managing companies and in protecting the company and its shareholders from risk. Their main fiduciary role is to plan and strategize goals and objectives for the short- and long-term good of the company and to put mechanisms in place to monitor progress against the objectives. They have an obligation to ensure the long-term well-being of their company by supporting management in developing a compelling innovation strategy, which will enable them to develop the kind of breakthrough innovation that is needed. However, in doing so it exposes them to operational, financial, technological and potentially legal risks. It’s no surprise then that many prioritise short-term goals rather than riskier long-term choices, especially given their fiduciary responsibilities and need to regularly answer to shareholders.

Embracing innovation and its inherent risks requires that boards and senior management develop new ways of working together. Boards need to move away from a risk averse and cautious role that they historically played and instead play a supportive role in encouraging innovation by trying to provide a longer-term and supportive approach to new ideas. They need to understand risks and try to provide solutions to mitigate them and in doing so provide the protection needed for innovators to do what they do best. In doing so they are providing responsible innovation needed to give their company the best possible chance of long-term growth and success.

Change in mindset

The change in approach isn’t just needed at the board level, it’s needed throughout the entire company. Boards need to create a culture that is receptive to risk and the inevitable failure that comes with innovative problem solving, in essence people shouldn’t be afraid to attempt something new and to potentially break a few things in the process of doing so. This may sound simple but it isn’t as it requires a fundamental shift in people’s mindset and the culture of the firm to move it towards being one of embracing creativity and new ideas.

The difference that corporate governance can make

Having good corporate governance systems in place can play a crucial role in supporting innovation, not in limiting it. It can help to provide the foundation for a company to take the kinds of risks that it needs to take whilst also providing the protection needed to mitigate it from issues if these risks fail.

Crucially, effective corporate governance provides innovative risk takers with the protection that they need to take the necessary risks needed without worrying that it will create issues for them and for the company. This freedom will allow these individuals to thrive and to push the company in the direction needed. Only in doing so will the company survive on a long-term basis.

This is the first part in a series of articles on the importance of innovation in corporate governance. We will delve into the issues raised above in more detail in future articles and also provide advice and frameworks needed for companies.

Proto Innovation considers effective corporate governance to be one of the most important topics for all companies to get right, not only to protect them and their shareholders from risk but to crucially develop the kind of innovation needed.

Photo by Sean Pollock on Unsplash