Blockchain’s potential for transforming corporate governance

The digital decentralised autonomous setup facilitated by blockchain technologies has several potential impacts on operations of existing corporate governance models.

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RECENTLY, American multinational investment bank and financial services holding company JPMorgan Chase & Co. announced the usage of blockchain technology to settle collateral settlements. This announcement marks a huge development, pointing to the success of blockchain technology in facilitating corporate governance.

What is blockchain?

Blockchain can be defined as an open distributed ledger capable of recording transactions between (unknown) participants in a verifiable and immutable manner. Information is maintained on a public ledger or a private ledger in a blockchain system that operates on a decentralised peer-to-peer network, and records all transactions that are conducted. Blockchain technology is defined by American multinational technology corporation International Business Machines Corporation as "a shared, immutable ledger that facilitates the process of recording transactions and tracking assets in a business network".

Blockchain allows virtually everything to be tracked and traded via its network. It constitutes an example of distributed ledger technology. Due to the associated benefits of risk and cost reduction, the technology is making talk of the market.

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What is the utility of blockchain in corporate governance?

The merits of the blockchain technology have made it an indispensable source in day-to-day transactions, especially in the realm of corporate governance. Corporate governance is concerned with maintenance of balance between economic and social goals. Blockchain technology has proved to be helpful in facilitating the removal of agents as intermediaries in corporate governance through code, peer-to-peer connectivity, crowds, and collaboration. Blockchain presents a great degree of enhanced accuracy, efficacy and transparency in share ownership, corporate voting, and record-keeping, replacing years-old corporate practices.

Existing corporate governance efforts against unavoidable agency problems fall short of achieving the required quality of governance and stability. Major issues show that basic agency problems cannot be fully resolved within the existing theoretical and legal infrastructure. At this critical juncture, blockchain-based technologies have begun to provide alternatives to existing corporate governance solutions.

Research has proved that the implementation of blockchain in corporate governance will result in more liquidity, cheaper costs, more accurate record-keeping, and transparent ownership. Integrating various bank ledgers using blockchain is supposed to speed up operations and lower expenses. Smart contracts, on the other hand, might lead to more collusive behaviour among participants. Blockchain applications also have a variety of applications in accounting, including triple-entry accounting, decreased earnings management, and real-time auditing.

Through coding, peer-to-peer communication, crowds, and cooperation, blockchain technology can aid in the elimination of agents as intermediaries in corporate governance. Blockchain-based assurances built in blockchain code can help ensure that no one participating in business and corporate connections is able to circumvent a set of governance norms.

What are smart contracts?

Blockchain assurances involve the usage of a contract between the principal and the agent only if and when all contract restrictions are reached by both parties, and confirmed in the algorithm for compliance. Thus, in blockchain infrastructure, the low level of agency oversight and monitoring alters the cost structure of the primary relationship with the agent. Moreover, smart contracts enabled by blockchain technology allow for complete, intimate and seamless relationships, as well as the cost-free agency communication of agency relationships.

Smart contracts, which are blockchain-based computer systems that assist, validate, monitor and enforce contract negotiation and performance between the principal and the agent, can overcome risky behavioural problems such as strategic failure, and can dramatically reduce the cost of verification and enforcement (indeed, attorneys may see their business dwindle significantly in a world where many contracts became compulsory). Decentralized, open-source software platform Ethereum uses blockchain technology to create smart contracts based on simple events such as the passage of time or complex emergencies such as future financial outcomes.

The digital decentralised autonomous setup facilitated by blockchain technologies has several potential impacts on operations of existing corporate governance models. In a private blockchain administered by the firm and only available to shareholders, the company and shareholders who own enough shares may post proposals. Smart contracts enable the private ledger to be built in such a way that all necessary information, including majority rules and access rights included in the articles of organisation and relevant legislation, is stored in the blockchain. When a specific proposal is posted in the blockchain, shareholders who own shares in the firm are instantly alerted and have a limited time to exercise their voting rights.

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What are the other ways in which blockchain usage can enhance corporate governance?

The transparency offered by the blockchain system will enhance the positions of executives not only in their firms, but also in the shares of other companies — including those of competing firms. This appearance may strengthen the performance appraisal systems. Many proposals for compensation reforms contradict existing performance appraisal models, in which the manager is rewarded with the payment of marked shares against the market or industry index.

In the blockchain market, cheap and fast trading and payment will make it easier to get in and out for major shareholders. Easy access will enhance institutional ownership and activism. Once investors have bought their position, they can choose to influence company executives by threatening to sell, exit, or negotiate and participate in a business vote, or by voice.

Many researchers who have analysed both channels, have concluded that an increase in the liquidity of the blockchain market should reduce sales costs and therefore lead to greater emphasis on going out against the voice. For example, in British academic Alex Edmans' 2009 model, liquidity increases the credibility of a blockholder owner to threaten to sell, which helps regulators persuade managers to improve project selection.

Similarly, researchers have found that retailer returns to consolidation are higher when consumer stock liquid prices are lower, which raises exit costs for institutional investors and gives them indirect motivation to use voice to prevent managers from pursuing negative profits.

Why is it necessary to regulate blockchain-based corporate governance?

Significant negative outcomes may spill over into the real economy, as changes in incentives for experienced investors to trade could lead to reliable signals about the number of individual firms. In the face of these changes, financiers may later designate securities differently, reconsider the need for certain limited agreements, and take advantage of blockchains' ability to make "smart contracts" automatically.

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Blockchain technology has the ability to give effective answers to numerous challenges that are wreaking havoc on present corporate governance structures. These technologies have the potential to improve corporate governance models by enhancing accuracy, accessibility, and efficiency — enabling better decision-making by shareholders.

Smart contracts using blockchains may give unique ways of controlling corporations in the future. Blockchain technology can lower shareholder voting costs substantially, and offers opportunities for enhancing the Annual General Meetings' ('AGM') forum function. In addition, it can also decrease the organisational costs for companies and increase the speed of decision-making, making the AGM a fast and lean corporate organ.

Blockchain regimes have vast abilities to alter the current scenario of corporate governance. Institutional investors, raiders, and activists may gain from being able to buy shares at a reduced cost and sell them in a more liquid market, but they will have a much more difficult time concealing their purchases. Due to the increased visibility of their activities, managers who get stock-based remuneration are more likely to miss out on profit opportunities from lawful insider trading.

Blockchains would also make it impossible for managers to backdate bonus awards or secretly pledge shares for derivative transactions. Shareholder voting would become far more dependable and cost-effective. Companies may potentially utilise blockchains for real-time accounting, decreasing the role of auditing companies, and for smart contract execution, which would minimise the estimated costs of the financial crisis and the necessity for litigation.

Together, these interventions mark a consequential disruption in the corporate governance sphere that would require fresh regulatory mechanisms in place.