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Venture Governance: A New Horizon for Corporate Governance.

Garg, Sam (AUTHOR) [email protected]

Academy of Management Perspectives. May2020, Vol. 34 Issue 2, p252-265. 14p. 1 Chart.

Article

*CORPORATE governance *NEW business enterprises *INFORMATION processing *CORPORATE directors HORIZON

board of directors corporate governance entrepreneurship

The corporate governance literature has predominantly focused on large, publicly listed firms. As part of this special symposium on innovations in corporate governance, this paper focuses on ventures as a novel governance configuration. It explains how venture governance mitigates some fundamental corporate governance issues, such as the agency problem; the presence of external directors who have limited motivation and insufficient sectoral knowledge, and are consumed by onerous compliance matters; and boards' formal structure and large size, which limit effective communication and information processing. But while novel features of ventures mitigate these fundamental issues in public firm governance, three new governance issues emerge in ventures: (1) the "principal problem," (2) customers as a source of external governance, and (3) lack of formal board structure. The paper presents evidence and observations on how these new governance issues are addressed in innovative ways by venture boards. Finally, it discusses the relevance of these new governance issues and solutions for public firms. [ABSTRACT FROM AUTHOR]

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HKUST Business School

9967

1558-9080

10.5465/amp.2017.0178

1

1

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Venture Governance: A New Horizon for Corporate Governance

The corporate governance literature has predominantly focused on large, publicly listed firms. As part of this special symposium on innovations in corporate governance, this paper focuses on ventures as a novel governance configuration. It explains how venture governance mitigates some fundamental corporate governance issues, such as the agency problem; the presence of external directors who have limited motivation and insufficient sectoral knowledge, and are consumed by onerous compliance matters; and boards' formal structure and large size, which limit effective communication and information processing. But while novel features of ventures mitigate these fundamental issues in public firm governance, three new governance issues emerge in ventures: ( 1) the "principal problem," ( 2) customers as a source of external governance, and ( 3) lack of formal board structure. The paper presents evidence and observations on how these new governance issues are addressed in innovative ways by venture boards. Finally, it discusses the relevance of these new governance issues and solutions for public firms.

Keywords: entrepreneurship; board of directors; corporate governance

The vast body of scholarly work on corporate governance has provided many important insights into the governance of publicly listed firms ([17]; [26]; [80]). Yet publicly listed firms are rapidly declining in numbers and lagging in innovation ([29]). By contrast, new ventures, especially those that focus on technology, are broadly viewed as drivers of innovation and economic growth ([58]). They attract top talent and hundreds of billions of dollars in annual investment from governments and the private sector. These ventures, which I define as privately held, professionally funded entrepreneurial firms ([38]), are often focused on product or business model innovation enabled by technology or engaged in developing new technologies. Scholarly attention to ventures is growing on topics such as innovation, founding teams, investors, and, increasingly, governance.

Given this special symposium's thrust on innovations in corporate governance, this paper seeks to focus on ventures. Ventures represent a novel governance configuration, including a distinctive ownership structure and board configuration. The unique governance configuration in ventures enables venture directors and CEOs to cooperate and create value, while avoiding major CEO missteps commonly found in large public firms. With these central issues in the CEO–board relationship still unresolved in the public firm literature, ventures present an attractive research context that offers new opportunities for corporate governance scholars.

This paper has two primary goals. First, I elaborate on the novelty represented by venture governance configuration vis-à-vis the large public firms with dispersed shareholders that have been the primary focus in the corporate governance literature. Venture governance configuration mitigates several of the central issues in the public firm literature, such as the agency problem; the presence of external directors who have limited motivation and insufficient sectoral knowledge, and are consumed by onerous compliance matters; and boards' formal structure and large size, which limit effective communication and information processing. I also present emerging evidence on the effectiveness of venture boards, which are the primary (internal) governance mechanism because these firms are not listed on the stock market.

Second, I explain that while novel features of ventures effectively mitigate some fundamental issues of public firm governance, new issues emerge. A major new governance issue that emerges in ventures is the replacement of the agency problem with what I refer to as the principal problem, which is a consequence of potential conflicts of interests of venture directors (as representatives of owners) as well as these directors'

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power and limited time. Other key governance challenges arise from customers as an external governance mechanism and a lack of formal board leadership structure that creates potential for delayed decisions and resistance to board formalization over time. I present evidence and observations on how these new governance challenges are addressed in novel ways in venture boards. Importantly, I discuss the potential application of these governance innovations in public firms, and how these new governance challenges can spur exploration of new boundary conditions and elaboration of the extant literature on public firms.

Overall, this focus on the novel governance configuration of ventures, and the new issues it surfaces and innovatively addresses, promises to expand the purview of corporate governance scholarship and also enrich the understanding of venture governance.

VENTURE BOARD COMPOSITION Initial venture boards tend to comprise only the founders and potentially a few individual noninstitutional investors such as personal friends or angel investors. Such boards are largely for formal reporting purposes and have limited functions. However, ventures are often asked to create a formal board of directors when they receive their first institutional investments, such as those from venture capitalists (VCs) or corporate venture capitalists (CVCs). This timeline is particularly common in the U.S. context, but it is also predominant in other major entrepreneurship hubs, including China, India, Israel, and the United Kingdom.

A venture's formal board of directors often includes both inside and outside directors ([38]). Inside directors are the CEO (who may also be a founder) and possibly another firm executive or two. Outside directors are often investor directors who represent the venture's professional investors, such as VC and CVC firms. They typically have significant industry knowledge and networks they can bring to the board. Outside directors may also include founders who no longer work at the venture and independent directors, who are typically senior executives in related industries ([ 6]). In contrast to public firm boards, where independent directors are a common focus, new ventures rarely have more than one or two independent directors.

Unlike in public firms, ventures do not hold periodic director elections at annual shareholder meetings. A venture's board composition may change as a result of the negotiation for board seats between the current board and new investors at the time of new rounds of equity financing. Not all investors receive the control rights they need to appoint their representatives to the board ([53]). Research indicates that investors are more likely to gain a board seat when they make larger investments ([ 4]; [65]), possess stronger capabilities ([13]) and track records, and have a larger network size and geographic proximity to the venture ([ 4]).

Other factors positively related to obtaining board seats include prior relationships with the founder ([ 4]) and co-ethnicity with the CEO ([12]). Diversity experience of the CEO helps to make the board more diverse ([ 7]). By contrast, strong venture performance and promising future trajectory increase the venture's negotiation power and reduce the likelihood that investors will gain board seats ([24]; [25]). Typically, board size increases with new investment rounds, often with an increase in both the number and proportion of investor directors ([ 4]; [61]). Unlike in public firms where director terms are often set at three years, the venture director appointment term, especially for investor directors, is often unlimited but can be renegotiated at new financing rounds.

Because venture boards have significant strategic involvement ([40]), it is relevant to consider whether other investor rights, such as cash flow rights and liquidation rights, can substitute for board involvement. While these other rights and contingencies provide control opportunities for investors ([53]), they provide limited information access and a restricted voice in the strategic decision-making process ([42]). By contrast, board seats offer a distinctive means of influencing a broad range of strategic decisions, as well as the venture's

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strategy and innovation trajectories ([37]; [40]), as well as executive and board recruitment and exits ([ 4]). These board seats, however, also create responsibilities for directors that they must discharge. Board members have individual-level legal duties toward the firm and are not supposed to advance their own interests, whereas investors are exempt from such obligations. In general, board seats are highly valued for the ongoing influence they can facilitate.

VENTURE BOARDS VS. PUBLIC FIRM BOARDS Ventures and their boards represent a distinctive governance configuration that addresses some key theoretical issues central to the corporate governance literature on public firms. First, the agency problem, which has been a fundamental issue in the corporate governance literature on public firms ([14]; [26]; [52]), is less central in ventures. Venture CEOs, whether founders or nonfounders, are financially and psychologically far more aligned with the firms' future performance than public firms' CEOs ([38]; [74]). As a result, ventures do not frequently confront the classic agency problem of CEO misalignment that often occurs in public firms ([ 5]). Beyond alignment, information asymmetry with the board is mitigated by frequent board meetings (every four to six weeks) and regular dyadic interactions with the board members in between ([32]; [40]). Venture board directors often further mitigate information asymmetry by encouraging the hiring of CEOs, top executives, and external consultants with whom they have worked in the past.

Second, in contrast to public firm boards, venture boards are much more focused on customers. Public firm boards comprise mainly independent directors with limited industry knowledge and financial incentives ([27]; [28]). They are also under much external scrutiny, including from the stock market, analysts, and regulators ([ 2]). A key consequence is limited attention to customers and ultimately lower firm innovation ([ 9]). By contrast, venture directors frequently have a strong understanding of the venture's sector and are financially aligned with the venture's long-term success ([38]). Further, with lighter compliance obligations in many jurisdictions such as the United States, China, and India, venture directors can focus on helping already motivated CEOs to achieve rapid growth in product adoption (even at the expense of revenue) and ultimately a profitable exit through an initial public offering or a trade sale (M&A). This leads to an intense focus in ventures on customers and their evolving needs. Thus, venture boards optimize for different goals, and their attention is not consumed by the external pressures that public firm boards face.

Third, a lack of formal board leadership structure enables more interactions in ventures. Public firm boards are not just large in size; they are also required to have formal board committee structures that create silos and limit exchanges with other committees ([18]). This adds to the possibility of dysfunctional behaviors such as pluralistic ignorance ([78]; [80]). By contrast, venture boards are much smaller, with 4.3 members ([ 4]) compared to 7.5 members for public firms in the U.S. ([64]). For S&P 500 firms, which are often the sample in much of the corporate governance research, my analysis shows that the board size is even larger (11 directors for the 2015–2019 period). Venture boards typically have very limited formal structure and frequently have no board chairs or board committees ([39]; [50]). A consequence of this less formal structure is greater connectedness on the focal board, which implies more information flow and engagement. These boards have more opportunities to discuss strategic issues and have greater shared understanding among the board members.

Although I present venture boards and public firm boards as polar types to underscore their key qualitative differences, there is admittedly variation among both ventures and public firms. For example, in heavily funded "unicorn" ventures (e.g., WeWork), CEOs may sell a significant percentage of stock to other investors. This can lead to greater agency problems than those seen in typical ventures, even though these CEOs may continue to identify with the venture and a significant portion of their net worth remains tied to venture success. Similarly,

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there may be other rare variations in ventures such as Theranos, which raised hundreds of millions in venture capital investment but had a board of directors composed mainly of senior politicians and military officers who were not as informed of its industry sector and not as incentivized to actively contribute.

I also note that some components of venture boards may be similar to those of boards in other organizational forms, although these components are aligned differently in venture boards and the overall configurations are unique. For example, in nonprofit organizations, the CEO (often called the executive director) may also be aligned with the organization, and some of the directors may be knowledgeable. Directors of these boards, however, do not necessarily have financial alignment or sectoral expertise. And such boards are often too bureaucratic due to their large size and too consumed by the need to manage relationships with the donors, thereby limiting the directors' strategic involvement. The boards of family-managed firms are also different from those of ventures. Although these directors have alignment in financial incentives, they are mainly family members or loyalists and often not sectoral experts. In addition, these boards are not driven by the strategic logic of rapid growth that is common in ventures, and family boards emphasize community involvement and reward loyalty, often retaining long-tenured employees despite their limited qualifications. By contrast, in new ventures of the nature I emphasize, a CEO may be preemptively dismissed as the board prepares for future growth ([73]).

Finally, in publicly listed firms, activist directors—as representatives of certain institutional investors—may seem similar to venture investor directors, but such directors often focus on financial engineering, operational improvements, and turnover of the CEO and some long-tenured directors, rather than assisting and advancing strategic goals such as innovation ([56]). In addition, their approach is often confrontational (including lawsuits), in contrast to the consensual approach that is more common in venture boards. I suggest, then, that although boards in ventures and other organizational forms may have some similar components, venture boards represent a unique configuration that has led to a growing academic literature.

EFFECTIVENESS OF VENTURE BOARDS Venture boards seem to address some key issues at the heart of public firm corporate governance literature. The emerging literature on venture boards ([41]) indicates that these boards are indeed often effective—they both closely monitor the CEO (per agency theory) and provide resources (per resource dependence theory), ultimately supporting a firm's rapid growth ([37]). This role stands in contrast to the general and arguably more dismal view of public firm boards, which are seen as beset by agency problems, lack of director expertise and financial incentives, onerous compliance that leaves little time for strategic engagement, and ultimately board size and leadership structures that stifle board communication ([17]; [80]). As one senior policymaker of a leading stock exchange privately confessed to the author, "We think the corporate governance literature on public firms does not say much on how we can improve governance. It is disappointing."[ 1]

The strategy and organizational literature on venture boards has frequently employed the resource dependence lens ([66]). This approach is appropriate, especially given ventures' limited resources. Research finds that boards can be a critical source of advice ([82]; [84]), can complement top management teams ([15]; [57]; [83]), and are likely to be involved in strategy ([37]; [40]). Directors play an important role in changing personnel, formalizing human resource policies. speeding up product commercialization ([16]; [33]; [49]; [73]), deciding on acquirers ([ 4]; [47]), facilitating alliances ([11]), gaining investment ([35]; [48]), and signaling prestige ([22]; [72]).

The literature has also begun to explore several nuances of directors' resource provisioning. For example, [11] explored the network characteristics of board members. They found that venture alliance portfolios grow faster

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when their boards include directors with heterogeneous, multiplex relationships and central network positions within the venture's industry. They also established that outside directors who have central network positions and are not investors assist in more rapid formation of alliance portfolios. However, when the board is predominantly represented by central investor directors such as VCs, alliance formation slows.

Some researchers have also started looking at venture boards as being composed of diverse actors, and they have assessed the effect of those actors on firm innovation. Research on medical device ventures has found that there is an inverted-U relationship between the presence of directors who are users (i.e., physicians) and venture innovation ([54]). Other scholars have expanded this inquiry to examine the effects of different categories of directors (VC directors, CVC directors, and founder directors) on interorganizational ties, innovation, and exit in a sector of the medical device industry ([42]). [42] found that the proportion of VC directors and founder directors on the board is positively associated with speed and likelihood of first product approval. However, the higher proportion of VC directors is associated with lower patenting, suggesting that they are focused on commercialization. [42] also found that founder directors are much less influential than VC directors and CVC directors when considering a broader set of outcomes, including interorganizational ties (such as for R&D and supply chain where CVC directors are particularly influential) and exit events (such as initial public offerings and M&A). These findings suggest the usefulness of unpacking venture boards and relating the directors' incentives, power, and capabilities to different strategic outcomes.

Other work has recognized resource dependence as an exchange theory in which firms trade some power to access director resources ([66]). In a survey-based study, [75] examined the entrepreneur's ex ante choice between attaining the external resources needed for growth and maintaining control (including over the firm and the board). He found that choosing control led to a decrease in firm performance. Indeed, there is a tension in this resource exchange as also echoed in earlier studies—VCs attempt to offer advice in more areas than those in which CEOs actually seek value from them ([31]; [67]), and CEOs are less likely to value VC involvement when the VC has low status and the senior management team has significant industry experience ([10]; [67]). Further, given their role as investors, venture investor directors have conflicts of interest that can surface at the time of funding ([35]).

[40] examined how venture CEOs can ex post resolve the fundamental resource-versus-power trade-off in resource dependence theory to work effectively with their boards. They showed that board members can and do offer useful advice and resources, but suggested that we cannot assume this assistance due to directors' time limitations and sometimes conflicting interests. Using the inductive multi–case study approach, they tracked CEO–board interactions inside and outside the boardroom by observing board meetings and conducting interviews to develop a process framework through which CEOs can gain advice while maintaining power and control over the strategy process (i.e., effectively manage the resource–power trade-off that is at the heart of resource dependence literature in corporate governance). Notably, CEOs have a critical role in effectively harnessing the board, which has been largely left unexplored in the broader corporate governance literature.

Agency theory has also been applied in strategy and organizational studies on venture boards. Researchers who have used it focus mainly on VC directors. They have found that VC directors monitor more frequently with uncertainty, such as when there is substantial technological innovation, when the CEO has little experience as an entrepreneur or in the CEO role and the top management team is incomplete ([68]; [70]), when there are new M&A opportunities and missed performance targets ([46]), or when entrepreneurs do not communicate in a timely fashion ([69]). It should be noted, however, that this work largely tends to assess

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monitoring with indicators such as frequency of interaction, which arguably represents not only monitoring but also resource provisioning.

Research has also argued that monitoring—per the traditional agency-theoretic role of the board—can hurt venture performance because it can distract and demotivate the CEOs (and other executives) who are often well-aligned with the firm's success ([ 5]; [38]). In this vein, Twitter founder Evan Williams said about his board, "[I]f you put the board in a garage with ... entrepreneurs so that the entrepreneur has to explain his hunches rather than trying them out, it just kills the creative part that can lead to something good" ([76], p. 12). This quote suggests that value preservation through monitoring is not the most important role that venture boards can play in young ventures.

Overall, this emerging literature indicates that venture boards tend to be heavily involved, and that they help to improve key firm outcomes such as strategy, innovation, alliances, and exits. This confirms the expectations from the theoretical literature on how venture board configuration addresses key governance challenges in public firms, opening the door to corporate governance scholars, who may find it promising to explore the research opportunities presented by venture boards.

NEW GOVERNANCE PROBLEMS, INNOVATIVE SOLUTIONS I discussed above key differences in the composition of venture boards: the alignment of venture CEOs, a focus on growth and customers, and a lack of formal board leadership structures enabling greater board engagement. All of these characteristics create a high degree of strategic involvement of venture boards vis-à- vis large public firm boards. But while this novel configuration of governance characteristics in ventures addresses many of the key issues in the corporate governance literature on public firms, it also reveals a new set of theoretical issues that are likely to be of interest to governance scholars. Below, I discuss these new governance issues and present evidence and observations on venture innovations in mitigating these issues. I propose that these innovative solutions present new research opportunities that can expand the classic foci of corporate governance research.

The Principal Problem Much of the corporate governance literature centers on agency issues wherein the agent (CEO) is seen as a wayward agent who is monitored by the principal (the board, on behalf of the owners) ([26]). A large volume of literature has looked at how to create this alignment, and this continues to be the primary focus in the literature despite repeated calls for new directions ([17]; [26]). As described above, this traditional agency problem is less central in ventures. But while ventures are less prone to the agency problem, a central governance issue they face is the principal problem.

The central driver of the principal problem in ventures is that venture directors are sought for their sectoral expertise, but these directors frequently have conflicts of interest at the time of joining or develop these conflicts over time. Given their ownership of preferred shares, they have special rights over the inside directors; with this power, they can push the firm in nonoptimal directions. Directors may sometimes suggest strategies that advance their portfolio-level interests instead of promoting the best interests of the focal venture ([40]). For example, SoftBank Group, a Japanese multinational conglomerate holding company headquartered in Tokyo, has often been criticized by observers for making investments in competitors, such as in food- delivery and ride-hailing sectors, and then pushing for questionable strategies through its board involvement.

Legal scholars have also highlighted that investor directors in venture boards are often overly powerful and can be exploitative of the founders and other executives ([36]). Onerous preferential terms for investor directors mean that founders sometimes do not have any payoff despite M&A deals worth hundreds of millions of dollars

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([19]). Further, because investor directors have different payoff structures depending on when they join the board, they may calculate their personal gains when deciding whether to support major decisions such as a trade sale. In other words, venture boards present a governance configuration in which the traditional agency problem subsides but the principal problem (for the firm) rises, and this has received less attention in the corporate governance literature.[ 2]

A key innovation in resolving the principal issue in ventures is that the CEO behaviorally "flips" the principal– agent roles as typically conceptualized in the corporate governance literature. By taking the lead as a highly aligned actor, the CEO cultivates unique functional roles (e.g., sales, technology) for each of the directors ([40]). That is, he or she assigns the directors very specific things to do and advise on. And as this increasingly becomes common knowledge on the board, each director thus becomes accountable to the CEO and the rest of the board for his or her cultivated role. This has been shown to help mitigate the principal problem.

Can this innovative solution in ventures also apply in traditional public firms? The literature suggests that CEOs are often powerful in public firms, and director accountability remains an issue ([ 1]; [51]). Indeed, research shows that specific expertise is useful when it matches the needs of the firm (e.g., M&A, operations, deregulation, etc.), but this creates issues of accountability because expertise among the directors can overlap, leading to disagreements or even free-riding. By contrast, a configuration with unique roles can improve advice-giving to the CEO, and may also lead to better monitoring and advising of the top executives in charge of those specific roles. Unique roles can limit whether directors micromanage the CEO and, at the other extreme, make them more involved if they are less so; being responsible for specific roles, directors can also be accountable for their opinions and outcomes. This can enable the board to recognize the need for changing directors when roles are not as relevant.

Given the increasing number of activist investors on public firm boards, theoretical advances with the principal problem and ways to possibly mitigate them are potential new frontiers for corporate governance scholars. The principal problem in ventures also offers opportunity to the boundary conditions of the behavioral literature, which has sought to add social and psychological dimensions to the agency problem focus in the corporate governance scholarship on public firms ([80]). A focus on the venture context can advance the scholarship by examining how some of the behavioral drivers operate in venture boards where directors are powerful and prone to the principal problem. For example, scholars could examine the conditions under which homophily (emphasized in prior literature) or the economic logic might prevail for recruiting CEOs and directors. If the directors are deeply embedded in the local venture clusters (e.g., Silicon Valley), would the principal problem be amplified or subdued?

Scholars can push the boundary conditions of ingratiation in boards ([77]). On one hand, in the venture board context, it may be ineffective for CEOs to ingratiate themselves to the board due to the frequent interaction and information exchange among various board members and CEOs. On the other hand, boards with busier directors could be even more susceptible to such behaviors. Similarly, how do venture directors manage the tension between ingratiating themselves to the CEO so they get referred to for other investment opportunities and challenging the CEO to improve the prospects of the focal venture so they improve their reputation in the market?

Overall, examining venture boards provides an opportunity for corporate governance scholars to extend the traditional emphasis on the agency problem to the principal problem, and to explore the boundary conditions of the behavioral drivers that render boards less effective. This will help to develop richer models of the CEO– board relationship, and in turn will add to the growing evidence and literature on venture boards.

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Customers and Governance In addition to a focus on boards as the internal governance mechanism, there is a large literature on external governance mechanisms in public firms. Although the early focus was on the external stock market and the related market for corporate control ([26]), there is also increasing research on the role of the legal environment, auditors and analysts, media, and rating agencies, among others ([ 2]). Users/customers as a critical informal external governance mechanism, however, remains underexplored, even though they are ultimately the raison d'être for the corporation, especially for ventures. As noted above, boards are the primary driver of venture governance because ventures are not listed on the stock market; other external actors, such as rating agencies, analysts, and traditional newspapers, too, are less relevant as they do not pay much attention to young ventures. Yet customers are an important—and unexplored—source of external governance in ventures. As ventures are resource-poor, they have significant resource dependence on users/customers for survival; without the visible and continued support of users/customers, even the venture investors ultimately abandon the firm. Thus, ventures need to respond to customer reactions quickly and satisfactorily.

As early adopters of products and services, venture users/customers tend to be highly vocal about their experiences. In addition, social media technologies and social network platforms have enabled the dispersed users to come together and create online social movements when they are displeased. Ventures' strong resource dependence on customers obliges them to attend to these customers/users promptly and satisfactorily. Thus, theoretically, customer activism can shape the degree of freedom with which venture boards direct the firm and its strategy. I suggest that customers, then, become an important external governance mechanism in ventures.

Customer discontent expressed on social media has, for example, forced ventures to change market offerings, competitive behavior, and even human resource policies. Uber, when it was still a venture, arguably served as a prime example. Customer reports on social media exposed mistreatment of customers and drivers, use of deceptive software against regulators and competitors, widespread sexual harassment, and many other problematic practices. While some of these practices fell in legal gray areas, they sparked massive online campaigns that significantly altered Uber's strategic trajectory, and even ousted the CEO. By contrast, Airbnb showed a quick, responsive approach to online uprisings against the practice of renting "party houses," where guests mislead the hosts regarding the rental purpose and often engage in behaviors that damage the property and upset the neighbors. The result is that Airbnb is seen more positively by its users than Uber is. Cafédirect has an even closer relationship with its customers due to its high ethical standards: It doesn't just source fair- trade products; it also invests in the sustainability of the grower community through education and other life improvement initiatives. This leads to superior products that keep customers happy and loyal.

In some cases, customer activism has led to the tightening of laws or the establishment of new laws for the entire category. Interestingly, these laws are related to the protection of the dispersed users/customers rather than the shareholders, who have traditionally been the focus of public firm regulations. For example, users/customers have highlighted that many firms use weak laws to misappropriate user data and have avoided any liability for objectionable content on their platforms. In response, there has been significant tightening of laws in both the United States and the European Union (EU). For example, according to the EU's General Data Protection Regulation, misuse of individual data of EU citizens can lead to fines of up to 4% of global revenues of the firm. Some expect that this trend could be the "Sarbanes-Oxley moment" for data privacy in which all firms (including young ventures) become subject to comprehensive compliance requirements.

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By examining the venture context in which customer activism is particularly consequential, corporate governance scholars have an opportunity to expand the theoretical focus from shareholders, boards, and executives to incorporate customers, who have an unprecedented ability to mobilize action through social media. Theoretically, this larger focus captures the tension between prioritizing resource dependence toward users/customers versus resource dependence toward investors, who may be interested in taking significant risks for rapid growth and dealing with the user fallout later (the "do first, apologize later" approach).

Indeed, every venture pushes some boundaries and, therefore, can potentially cause discontent. Yet ventures and their boards cannot neglect customer activism on social media. What strategies do venture boards and executives use to pacify these dispersed users/customers, some of whom may be acting on behalf of competitors? Research into these areas can take corporate governance scholars beyond impression management techniques for advancing self-interests ([71]) and pacifying investors ([79]) to an exploration of avoiding disturbances in resource flow from users/customers (for an exception, see [59], on how customers can influence governance arrangements such as CEO duality).

Corporate governance scholars can also explore how venture boards engage with regulators—as individual firms and/or industry bodies or through lobbyists—in shaping the new, tighter laws in new sectors such as fintech. Given their knowledge and incentives, venture directors may seek to reframe the user/customer-led conversation and try to avoid regulations that can hurt their investments in the venture. Scholars may also examine board configurations that may be more compliant after the regulations are enforced.

Overall, just as the central issue in the public firm discourse is protecting the dispersed shareholder, an emerging key issue for venture governance is protecting the interests of the users/customers. This concern is a significant opportunity for broadening the corporate governance conversation by incorporating users/customers, who have been largely absent in the research on corporate governance despite their central role in firms' existence.

Limited Formal Board Leadership Structure Public firm boards are often unable to effectively discuss the information that comes their way ([17]). Structural inhibitors include large size, which limits information exchange, and board committees, which split discussions and limit intercommittee communication ([18]). By contrast, venture boards are smaller in size and have very limited formal board leadership structure (often no board chair and no board committees), which enables significant interaction among the directors ([41]). But while this venture configuration solves the problem of limited substantive interactions observed in public firm boards, it also generates the new potential problem of endless board discussions and delayed decisions. Slow decision making often hurts venture performance. This more fluid structure in ventures also creates a subsequent difficulty in formalizing the board leadership structure, which unavoidably creates a hierarchy among the directors (because only a subset of directors gets appointed to full board/committee chair positions). Corporate governance literature does not consider these potential dysfunctions.

Emerging research shows that ventures approach these unusual governance challenges in innovative ways. First, to mitigate the potential problem of endless board discussions and delayed decisions, venture CEOs work more effectively with their boards by not using their board meetings as opportunities for brainstorming or informal exchange of ideas ([40]). Rather, board meetings are used as formal interactions where backward- looking updates are provided and decisions are closed. Strategy discussions are held either in one-on-one conversations with directors on specific issues or in group brainstorming sessions that are dedicated solely to

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that purpose. This not only helps to curtail lengthy and unnecessary board discussions, but also contributes to more timely decision making.

Second, formalizing the board leadership structure requires an emphasis on fairness. Emerging research shows that ventures' formalization of the board leadership structure is ineffective if it leads to "board undervaluation"—that is, a situation in which chair appointments are not based on normatively accepted criteria ([44]). When directors are unfairly passed over for chair positions at the board or committee levels, they feel slighted; a negative justice climate ensues in the firm, with several adverse consequences. For example, when board undervaluation is higher, the directors are more likely to quit, the CEO is more likely to get fired irrespective of firm performance ([44]), new directors have lower overall qualifications than the incumbents with implications for firm performance ([42]), directors are less able to prevent upward earnings management ([63]), and firm innovation suffers ([43]). This highlights the importance of formalizing board leadership structure in a "fair" way, whereby the consequent hierarchy among the directors is normatively appropriate.

Can these venture board innovations also apply to public firms? Public firm boards need to deal with higher business complexity and more regulations, so a focus on formal meetings seems appropriate. Yet following practitioner calls (e.g., [21]), CEOs often try to squeeze in some brainstorming too during the board meetings. However, as venture research suggests, such an approach may be ineffective because of potentially unhelpful emotional spillovers from business updates to strategy brainstorming; any time constraints at the board meetings truncate strategy brainstorming. Thus, separating board meetings and strategy brainstorming sessions is likely to be effective in public firms too, but such sessions should not just be an annual ritual. As for the leadership structure, I expect the logic of normative legitimacy and fairness to apply to boards too, just as it applies to many other domains of organizational and social life ([23]). So when public firms shuffle their committees and hire new directors, they may benefit from paying attention to appointments based on criteria that are widely considered normatively appropriate.

The venture context can also help push the boundaries of what is known about the formal board leadership structure in corporate governance literature, which remains predominantly focused on the largest firms (e.g., S&P 500). Scholars have called for reviving and expanding the research on board leadership structure (e.g., [60]) and the life cycle of firm governance (e.g., [34]). By looking at ventures, scholars can get insights on the development of formal structures over the firm's life cycle. In particular, the venture context provides the opportunity to ask questions about the origins of the leadership structure earlier in the life cycle of the firm. Why do some firms have formal chairmen and some do not? Why are board committees formed in firms when they are not mandatory? Do these initial formal structures imprint the organization after they go public, and if so, how? CEO duality is considered effective in more dynamic environments, but a common alternative in ventures is to replace the CEO; which one is chosen and when? The venture context also provides a unique opportunity to explore the interplay of formal board structures and informal processes as business complexity changes with firm growth. For example, are the issues of groupthink and group pressure more or less severe when there is less formal board structure?

Overall, there is an opportunity for corporate governance scholars to explore how to make their boards work more effectively through appropriate processes and formal structures. Ventures also provide a unique opportunity to understand the origins and evolution of the formal board leadership structure.

DISCUSSION AND CONCLUSION In this paper, I have argued that the novel venture governance configuration mitigates many of the limitations of public firm governance. Yet it also gives rise to new and unexpected governance issues that ventures can

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then address in innovative ways. These mitigation approaches to the new governance issues are relevant for established public firms as well, though they still need to be empirically tested.

I discussed three key governance issues that the venture configuration mitigates (see Table 1). The first is the classic agency problem, which forms the bedrock of corporate governance scholarship ([14]; [52]). Given ventures' strong CEO alignment, agency problem is less central in ventures. In its place, however, the principal problem is a key issue because of venture directors' power, high involvement, conflicts with other portfolio firms, and limited time. Venture CEOs resolve the principal problem by "flipping" the principal and agent roles in the CEO–board relationship—that is, the CEOs are better aligned and take charge to cultivate unique functional roles for all directors to create accountability for their behavior.

TABLE 1 Issues and Solutions in Venture Governance

Public firm issues mitigated in ventures

New issues in ventures Ventures' innovative solutions to the new issues

Agency problem Principal problem CEOs behaviorally flip principal and agent roles to cultivate unique functional role for each director

Limited attention to customers

Customers as core external governance mechanism

Close relationship with customers and codevelopment of regulations

Overly formal board structure

Limited or no formal board leadership structure

Board meeting as formal process, with separate brainstorming sessions; board formalization as a fair process

The second problem that ventures mitigate is the lack of attention to customers as an external governance mechanism. Although customers should be a core focus for all firms, they are often neglected by public firm boards due to onerous compliance requirements ([64]); customers have also received very limited attention in governance scholarship, which tends to focus on other external governance actors such as stock analysts and media (see [59], for a notable exception). By contrast, customers are often the central focus of venture CEOs and directors looking to achieve rapid growth in product adoption (even at the expense of revenues), which ultimately helps with the initial public offering/trade sale they seek. The key issue, however, is customer management, and thus customers become the key external governance mechanism in ventures.

Finally, venture boards have a limited formal board leadership structure (or none at all) and small size that help to mitigate the problem of ineffective communication and information processing on public firm boards ([17]; [80]). However, the problem in ventures tends to be the opposite: too much and too frequent discussion that can delay decisions, which can be costly in the high-velocity environments ventures often operate in. Ventures address this by making the board meetings a formal interaction and not mixing brainstorming, which is best done as a separate focused event. They also ensure that formalization of the board leadership structure, which is inevitable as the business size and complexity grows, is done in a way that the consequent hierarchy among the directors is normatively appropriate.

I propose that these new governance issues and innovative solutions are likely to be applicable in the public firm context. For instance, the principal problem is possible when there are activist directors on the board; customer focus is necessary, as exhibited by recent customer/user protests against Uber and Facebook; and effective processes for a positive board climate are necessary if the formal structure is mandated—neither acquiescent boards nor micromanaging boards are helpful. The insights I presented in this paper can help researchers explore new solutions to these governance challenges in public firms. In turn, ventures would be a useful and generative context to test the boundaries of key insights from public board scholarship, and even to discover new challenges and issues. As public firms decline in numbers and ventures play a larger role in

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economic growth and innovation, the time seems ripe for corporate governance scholars to take a closer look at venture governance for new research directions.

Implications for Public Policy This paper also has several important implications for public policy around entrepreneurship. Numerous economies now have policies to encourage formation and growth of new ventures, including through co- investment by governments ([ 8]), tax breaks for investors and ventures ([55]), and even lowering of barriers to enable these ventures to ultimately become publicly listed firms ([30]). This paper calls for policy attention beyond venture funding to venture governance, and effective transition of ventures into publicly listed firms.

First, policymakers can protect the interests of ventures by increasing the disclosure requirements on extant and emergent conflicts of interest for investor directors. Research shows that such conflicts of interest are not uncommon due to the structure of the venture capital industry. So rather than leave it to the ventures to protect themselves from the principal problem ([40]), policymakers can establish rules to protect ventures, especially those that benefit from public funding at some stage.

Second, in the public interest, public policy should also protect against ventures' aggressive growth tactics, which may include mistreating customers/users. New policies are needed to disincentivize ventures' transgressions against customers and users, possibly in conjunction with customer protection bureaus that are often ill-equipped to deal with technology-savvy ventures. Ventures, especially those supported by public money, should not be allowed to hurt the public interest.

Third, this paper's arguments have implications for public policy with regard to more mature, established firms.[ 3] Recent developments related to the COVID-19 pandemic clearly indicate that there is an increasing pressure on large corporations, especially in technology and engineering sectors, to respond to public demands to develop relevant and innovative solutions to various problems (such as the shortage of medical supplies like ventilators and masks) associated with the global crisis. These pressures bring mature firms on par with their entrepreneurial peers by forcing them to be more sensitive to broad customer demand, including other stakeholders such as governments and health officials. Our discussion suggests that public policy with regard to corporate governance should shift its focus from protecting shareholder interests toward encouraging various elements of venture governance outlined above, even among mature, more established peers.

Finally, this paper also has implications for the crucial transition of ventures into publicly listed firms. Much policy focus has been on independence of outside directors and on lowering of regulatory barriers to help ventures get listed on stock markets. Yet often the best of the ventures (i.e., those that become publicly listed firms) underperform after being listed ([20]). Using the behavioral research highlighted in this paper, policymakers can provide guidelines on the formalization of the board leadership structure at initial public offering. Specifically, they can emphasize avoiding board undervaluation to help superior firm performance ([44], [42]), more innovation ([43]), and less accounting manipulation ([63]).

Implementing these ideas on venture governance may require significant cooperation among policymakers responsible for entrepreneurship, corporate governance, and consumer protection. But with the increasing importance of ventures for growth and innovation in the economy, such public policy coordination is likely to be worth the effort.

Footnotes 1 Personal interview.

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2 This paper examines new ventures vis-à-vis the archetypical publicly listed firms with dispersed shareholders, and our focus is on the principal problem in the CEO–board relationship. Indeed, prior literature has examined the related issue of principal–principal conflicts among different categories of investors with concentrated ownership, such as in family firms ([2]) and firms in emerging economies ([81]). Such principal– principal conflict may be resolved through the power of one's own shareholding ([62]) and/or possibly a coalition with the others ([85]).

3 I would like to thank the symposium editors for their help in articulating this point.

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~~~~~~~~ By Sam Garg

Reported by Author

Sam Garg is an associate professor of management at HKUST Business School in Hong Kong. He obtained his Ph.D. in organizations, technology, and entrepreneurship from Stanford University. His research centers on high-growth technology firms, specifically board processes and leadership structures, strategic decision making, and power dynamics. His current research focuses on effective board processes in privately held technology ventures, and effective board leadership structures when these ventures transition into publicly listed firms.

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