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The psychology of regulation: ‘involvement’ versus independence

Date:02 October 2017
Floor Rink
Floor Rink

Regulators are well aware that management behaviour is largely determined by the corporate culture within an organization. However, in practice, shaping corporate culture is trickier than it sounds. People struggle with questions such as what is an ethical working climate? How can you create one? And do certain cultural adaptations really prompt managers to act with more moral responsibility, in line with the agreed standards and values? Psychological insight suggests that the distance (‘relational identity processes’) between managers and supervisory boards plays a key role in how effectively regulators guide management actions. According to social identity theory, people are more easily and effectively swayed by groups to which they belong, because these groups say something about who they are; they form people’s social identity. This is also true of these two parties.

It isn’t easy to study the relationship between managers and regulators without making generalizations about the latter. There is a distinction between internal regulators working from within an organization, for example supervisory boards, and external regulators based outside an organization, such as De Nederlandsche Bank. We tried to find out which of these two forms of regulation is the most effective. In other words, is it better to be close to the action or do you see things more clearly from a distance?

The classic, economic assumption is that independence is of the essence; supervisory boards must be able to form an objective opinion about management, and there must be no conflict of interests. If you follow this line of reasoning, internal regulators, which experience management decision-making processes at first hand, should be less effective than external regulators, which observe these processes from a distance.

On the other hand, social identity theory claims that the party to which management is accountable has a major impact on its effectiveness. After all, managers who respect and value their organization are more likely to modify their behaviour for people who work for the same organization (their equals) than for the sake of outsiders. If this assumption is correct, management may well be more receptive to criticism from an internal regulator than from an external regulator, on account of the internal regulator’s involvement with the organization and commitment to a shared cause. In their dealings with external regulators, managers may pay lip service to rules imposed from outside, without internalizing them as standards of behaviour.  In other words either external regulation is better, because it is more objective and does not involve a conflict of interests, or internal regulation is better, because there is more commitment to the same cause.

To test these two contradictory arguments, we asked all the managers and all supervisory board members at 56 insurance companies to complete an anonymous questionnaire about their cooperation with each other. The managers were also asked to assess their external regulator, De Nederlandsche Bank. We discovered that managers are more inclined to listen to their internal supervisory board than to external regulators. This is particularly true if the board regularly appoints new members, as it takes the pressure off the relationship between management and supervisory boards. An interesting point is that if a conflict between the management and supervisory board does arise, De Nederlandsche Bank has considerably more influence. In such situations, the external regulator becomes a highly effective mediator.   

These results are very useful to both regulators and managers; they confirm the idea that it is important who makes the rules. So, a better understanding of identity processes helps those concerned to understand and shape organizational culture. In practical terms, the findings also prove that involvement is perhaps more important than independence when it comes to regulation! The study may also be of huge benefit to external regulators seeking to increase their influence on management.

  • De Waal, M., Rink, F., Stoker, J., & Veltrop, D. (2017). How the dynamic interplay between TMTs, Internal supervisory boards and External regulation agencies affect TMT reflexivity. Manuscript in preparation. University of Groningen.
  • Prof. F.A. (Floor) Rink works in the Faculty of Economics and Business, conducting research into diversity, hierarchic differentiation in groups, staff mobility and the performance of management boards.