Management quality, governance ¹ and economic productivity

Conference cycle "A Economia e o Futuro” (“The Economy and the Future”)

Faculdade de Economia da Universidade do Porto

23 September 2019

Carlos da Silva Costa, Governor of Banco de Portugal ²

Good afternoon.

It gives me great pleasure to be here at this session, which places the themes of management quality and governance models and practices on the agenda of this opening of the academic year. These themes dominated the conference cycle of the last academic year and have strategic importance for our country’s economic development, with schools such as this one playing a key role in this field.

We realise that we need more and better economic growth to move our productive capacity closer to Portuguese society's legitimate aspirations of individual well-being and collective equity. 

In the case of Portugal, more economic growth does not mean working longer hours; it means considerably increasing the productivity of each hour worked. This necessarily involves investment in improving management quality, in a broad sense, which includes not only the managers’ skills, but also the suitability of management models and governance practices.

Indeed, the relationship between firms’ management and their productivity is well documented. Well-known academic studies by Professor John Van Reenen estimate that approximately 30% of the productivity differences between countries are explained by differences in management quality^[3]. 

Other research specifically shows the impact of the quality of entrepreneurs and managers on their firms’ performance. Leaders with higher levels of formal qualifications build more productive organisations that can grow faster ^[4].   

An important part of this impact naturally operates through the management models adopted, in terms of the interaction between “environment, organisation and strategy”, as chosen by the manager.

The 2018 Global Competitiveness Index published by the World Economic Forum ^[5] shows that Portugal has room for improvement in the quality of its management models. The list of indicators for which we rank less favourably includes:

• Attitude to risk, for which we come 80th out of 140 economies;
• Willingness to delegate authority, 70th out of 140;
• And integration of disruptive ideas, 46th out of 140.

So, we need managers and governance and management models that open themselves up to risk and disruption, promoting decentralised decision-making. 

The innovations of the last few decades, in the field of information and communication technologies, have made the production and distribution environments extremely volatile. Firms need to respond continuously to new markets, products and processes and for this purpose have to sustain fast and permanent mutation. This state of constant mutation requires intelligent and agile management. 

In this regard it is also important that management opens itself to the world. Research shows that the presence of a manager with experience of exporting increases the likelihood that the firm will start, maintain or intensify its export activities ^[6].  The exposure to international markets offers managers valuable opportunities to learn, positively differentiating the quality of the management models. This is particularly relevant for Portugal, where we will have to continue to redirect resources to the tradable sector, if we want more balanced and sustainable economic growth.

On a recent visit to a number of small and medium-sized enterprises in the north of the country, from sectors as diverse as industrial-use textiles, footwear, metalworking and renewable energies, Banco de Portugal has had the chance to see the excellent examples of managers and management models existing in our country.

This tour of the business community arose as part of the strategic relationship that Banco de Portugal aims to maintain with the broad range of stakeholders interested in the Bank’s products. Visiting the firms where they operate provided deeper insights into their environment, strategies and management practices.

The main success factors identified by the firms we visited included investment in internationalisation, customer orientation, openness to innovation, product differentiation and a very clear focus on long-term sustainability.

The subject of firms’ sustainability is particularly relevant for the Portuguese economy, as our manufacturing base has a strong component of family firms being handed down to the third generation. Here, it is vital to think how we can reconcile the family ownership of firms and the professionalism of management. 

A firm whose limits are the horizons of its founder or the founder’s family runs the risk of 

• being constrained by the management capabilities and control of that founder or family,
• or becoming attached to its first product, process or technology.

In turn, these constraints limit the size and longevity of firms, resulting in a community of relatively small or ephemeral firms, which inevitably influences the economy’s aggregate productivity ^[7].

To free firms from these limitations and ensure their sustainability, they must gain scale, professionalise their management and build a complex organisation that responds effectively to the market and embraces innovation. The openness and growth of the firms’ capital have strategic importance for responding robustly to all these challenges.

In this regard I have argued for the development of a standardised model for family holding companies with statutory recognition and a tax regime that not only reconcile family ownership and professional management, but also incorporate and protect the aspirations of all the stakeholders, thereby opening the way to more solid governance models.

These family holding companies have been introduced in various countries, including Spain, to facilitate family firms’ governance and transmission from generation to generation. These holding companies allow the equity, which is easily shared among heirs, to be separate from the management, which should not be shared and need not be bequeathed. The experience of those working in support of Spanish family firms suggests that a family firm paradigm should evolve into a corporate family paradigm. In this, the firm’s interests take centre stage in the family’s decisions over the succession formulas and the governance models. 

We should remember that governance models, even in firms based around families, have consequences for society: governance is not a private subject, it is a matter of public interest. There is a common interest that overrides private interests, which is that of the continuity of institutions. When a firm collapses, it takes with it a set of expectations. 

Institutions have a social capital, the loss of which has a negative impact on the economy and a cost for economic and social development. This means that governance does not only involve the establishment of a balance between equity owners, or between the latter and the managers, but involves all the stakeholders.

The markets themselves are now requiring firms to broaden their set of stakeholders and the value system that guides their decisions. 

• A growing number of consumers use their value set to guide their choices.
• More and more investors use sustainability requirements when choosing projects.
• The new generations of workers entering the job market for the first time will quickly abandon firms that they do not regard as responsible.  

There were clear signs of good governance also contributing to the success of the firms that Banco de Portugal visited in the north of the country.

• In several of the firms, the patience of the owners and their long-term stance are key drivers of their day-to-day success, relieving the pressure to make immediate profit; in one of the examples, the founding family even created a fund and transferred ownership of the firm to it, giving up executive power.
• We also came across great involvement from knowledge centres, customers, the local community and even competitors, in many of the firms’ strategic, productive or marketing processes.
• In regard to labour, the leaders widely recognised the importance of always keeping their workers satisfied and fulfilled. This recognition is exemplified in the effort they make to offer an attractive work environment and opportunities to develop skills. 

The success of the firms that received us is not limited to the people working within them. It mobilises the whole local community and in some cases develops a whole region, especially when it leads to the creation of industrial clusters or virtuous circles of intra-sectoral cooperation.

In sum, management quality results not only from the managers’ human capital, but also the management model adopted by them and the governance model that lets them balance all the interests hinging on the firm’s performance.

It would have been hard to choose a better topic for this session, given that the quality of governance and management are core elements of aggregate productivity and as a result are indispensable for the Portuguese economy's sustainable economic development.

I would like to finish by thanking you for the invitation to be here, wishing the Faculdade de Economia da Universidade do Porto a prosperous academic year ahead, and leaving you with a very clear challenge. 

Education and research can perform a key role in understanding and overcoming obstacles to the improvement of management models, while identifying and measuring the relationships between management quality, productivity and financing. 

With this in mind and by way of example, I leave you with some questions that are particularly relevant from Banco de Portugal’s viewpoint and that belong on a research agenda that advances reflection on governance and management quality:

• how can the capitalisation of firms lead to better management?
• how can management quality prevent default on financial commitments?
• or, how can financial stability be helped if commercial banks attribute greater relevance to the management models, in the assessment they make of corporate clients’ risk?

I believe that this school and the generations of economists and managers that it teaches year upon year are best placed to produce important knowledge in these areas, while helping firms on the ground renovate and modernise their governance and management models.

Thank you very much.