The Key Issues Influencing Innovative Activities

Published Date: 02 Nov 2017

The influence of innovations on a company�s success is undeniable. Innovations ensure long-term competitiveness and growth. Therefore, the capability to generate innovations is unsurprisingly described as one of the most significant lever for profitability and increasing growth. The innovation process, whether formalized or not, represents the heart of corporate innovation activities. It comprises different stages ranging from ideation to market launch and beyond. Thus, an innovation�s success is highly depending on a well-designed innovation process. Steady evaluations and adjustments of the process are necessary to avoid problems and to be prepared for long-term changes in customer needs, markets and the company�s business environment.

In this study we are seeking to determine how corporate governance impacts the innovation organization and performance in the Egyptian small and medium sized enterprises (SMEs) sector at all stakeholder levels with the aim to develop a new model that characterizes the impact of Corporate Governance on the success of Innovation Process.

1.2 PROBLEM STATEMENT

Innovation is a crucial component yet difficult to manage in all modern firms and especially in SMEs. This is due to complexity of implementation due to impact of firm's stakeholders on all aspects of innovation . Turning a firm into an innovative one is extremely difficult especially in the SMEs Context. Literature suggests that as executives become stronger or more entrenched, they alter corporate investment strategy to favor their interests over the interests of shareholders. This is consistent with the view that agency problems impose significant costs on the shareholders of the firm. SMEs also are suffering from Family Ownership problems, Structuring issues, Difficult Access to Finance, Difficult access to skills and missing know- how which affect their capability to manage innovation effectively and efficiently. It is evident that SMEs can benefit from Corporate Governance but the evidence that governance influences innovative activity ( and how) is still weak and currently not well established particularly in emerging markets.

1.3 RESEARCH OBJECTIVES

The overall aim of this research is to contribute to the efforts made to facilitate the adoption of innovation in SMEs. The specific objectives of this research are to:

� Extend the limited empirical evidence and research on the influence of corporate governance by examining the impact corporate governance has on the innovation process success of a firm within the SME sector .

� Develop a new innovation model that bridges the gap and takes into consideration the corporate governance theories and literature as part of the overall factors impacting the innovation process

� Identify and define key relevant Corporate Governance Dimensions (CG) and the way they are affecting innovation in small- or medium-size enterprise (SME) in Egypt , as an illustrative case of an emerging market.

� Build a causal and effect based model to allow firms to understand better the impact of CG on SME's innovation.

1.4 SCOPE OF THE STUDY

Importance of SMEs Sector

SMEs stand for small and medium enterprises which spread with all their activities widely across trade, services or manufacturing. In Egypt, SMEs were accounting for 65% of activity in small and micro establishments in 2003 and 97% of Egyptian enterprises are extremely small (employing between 1 and 49 workers)

SME in Egypt forms the number one employer since 1980 in all non-agricultural sections. SMEs differ in many ways such as size, location, ownership, legal setup and economic activities but they are all forming the major source of job creation and they are proving a significant share of the total added value

Statistics about this sector are not accurate but the number of SMEs (defined as those companies with up to 50 workers) was estimated in 1998 to be around 3.3 million economic units, compared to 2.9 million in 1988. Total employment in the SME sector grew to 8.3 million by 2004 with 40% of total employment and 80% of private sector employment(Egypt UNDP Report, 2005)

Since SMEs employ so many people and because they function across such a broad range of economic activities, SMEs represent a particularly attractive candidate for future growth.

The SMEs can act as feeder industries for larger companies and they are seen by many as potential engine for growth. Also SMEs are able to offer large numbers of jobs at a low cost because worker�s share of capital in micro and small enterprises according to a survey conducted by Ministry of Foreign Trade is small than with larger companies(which shows that they must be differentiated in terms of their potential and problems from larger companies with 50 or more workers). One of the major advantages of SMEs sector is their usual dependence on their own savings and private resources to finance business which injects money to the Trade and the business sector. The survey also show that the formal sources of finance (such as commercial banks, SFD or NGOs) supply just 6% of SMEs with their initial capital.

The decline in government employment has driven a growing numbers to join the SME sector to become self-employed or employers themselves. This also has led to increasing number of women especially to added value to the employment power of Egypt in areas that can exploit female skills.

SMEs also is important because

o They foster an entrepreneurial culture and provide resilience in the economy which increases innovation and competitiveness of the economy

o They contribute to exports . In some emerging markets such as in Pakistan, SMEs dominate the fastest growing export sub-sectors, such as cotton weaving and surgical instruments.

o They are an important vehicle for poverty reduction through employment generation and also touching new forgotten segments such as women

o Sectors dominated by SMEs usually facilitate learning geographically and across the sectors. Due to SMEs dynamics and mobility, these sectors usually generate higher levels of competition which in turn forces higher levels of learning. This is useful to create sustainable growth for the economy.

o SMEs social role is more efficient than others especially in resource allocation because SMEs can raise employment at lesser capital costs.

Definition of SME

The criteria used for arriving at the definitions are variable but are based on a few important principles:

o Number of workers

o Gross sales or annual turnover

o Total assets, capital assets

o Ownership (Independent/owner operated/family owned)

o Taxable income/profits

A classification of SMEs developed to manage and handle the problems of that sector and it is based on number of workers (MOFT - Small and Medium Enterprises Policy Development Project, 2003), In this governmental classification the SMEs are divided into three categories

� Micro enterprises (1-4) workers.

� Small enterprises (5-14) workers.

� Medium enterprises (15-49) workers.

Nilex is the Egyptian Exchange' market for growing medium and small companies. Nilex is the first SMEs stock market in the Middle East and it was launched in 2007.

Nilex defined The mid and small cap companies that are eligible to join as companies whose issued capital is not more than EGP 50 million or its equivalent in foreign currencies(EFSA�s BOD Decisions, 2011)

In this research we are adopting the Nilex definition for the following reasons:

� The application of Corporate Governance in Egypt is not mature enough and the only companies trying (and interested) to adopt Corporate Governance are those listed in the Stock Market in general. This is because they must follow governance rules to make sure they eligible to stay in the market

� Egypt is encouraging Nilex as main driver for rebuilding economy after 25th of January 2011 Revolution due to its ability to support the Access to Finance dimension

1.5 WHAT ARE THE KEY ISSUES INFLUENCING INNOVATIVE ACTIVITIES IN SMEs IN EGYPT?

Access to Finance:

Innovation is known as a high risk activity and in developed countries there is an echo system that balances between entrepreneurs use of their personal savings and the amount they get from external sources such as banks and angel investor which decreases risk. That�s why Access to finance is important factor for Innovation. (Lazonick,2007)

The dependence on personal saving although it is attractive as a feeder line for Economy but it is forming a critical issue preventing many SMEs from success. Access to financial services remains restricted and untapped because lending options are subject to costly terms. It is estimated that only 10% of SMEs have access to formal credit.

Failure to finance is not only affecting SMEs on how to perform but also building a barrier to many entrepreneurs to build their own startup because of fear of risk which affects the percentage of innovative SMEs. (MOFT, 2004)

Egypt has a legacy of government employment which is inherited from the socialist period during fifties to late seventies. That's why the entrepreneurship and innovation is fairly new terms to the Egypt and any failures that affect the entrepreneur personal savings can spread around and be magnified and increase the barrier to entry to the business world by New Entrepreneurs. This fear is also affecting shareholder ability to pursue with innovative projects

The good corporate governance practices may help companies to grow or attract different levels and types of investors to raise funds instead of borrowing from banks at high interest rates. Additionally, corporate governance is a primary eligibility criterion to allow a company to be listed in stock market which allows it to raise funds also through Initial Public Offering (IPO).

Formal Setup:

SMEs are by nature candidates for innovation but also the time and money consumed usually in regulations concerning establishment, operations, copyrights, licenses, patents,�etc is a major problem affecting this sector which usually result in majority of SMEs to work on an informal basis. This has lead for years to inaccurate statistics about the sector which affected all efforts made by government and NGOs to help SME because simply they cannot plan for the unknown. (MOF,2004)

It also affects formal participation in the economy, limits access to formal health, safety and social security procedures, diminishes net worth or opportunities to provide collateral through formal ownership of assets and reduces the potential for linkages with larger enterprises and government procurement processes. (MOF,2004), (UNDP,2005)

The informal activity of SMEs is also affecting Mergers and Acquisitions of SMEs by larger companies which is very negative and killing innovative SMEs wishing to grow to the next level. Lack of formality also makes it difficult for SMEs to sustain with the expected human resources turnover in this sector which can lead to complete loss of the innovative idea or project to a rival or competition.(MOFT - Small and Medium Enterprises Policy Development Project, 2003)

Knowledge:

In Egypt, SMEs are usually built around the Entrepreneur which in most times has the technical knowledge needed to operate and innovate but lacks the technical business knowledge or formal training on how to start the business due to lack of eco-system that facilitates and grow SMEs. (MOF, 2004) Although education improves the knowledge and opportunities open to entrepreneurs, it is not a sufficient condition for success, since it does not prepare future entrepreneurs with management or technical skills. The curriculum, whether at secondary or tertiary level, needs to promote basic practical or market-orientated proficiency as a prerequisite to a rounded education.(UNDP, 2005)

The Missing market know-how can be summarized as

o to meet customer�s needs

o to enter foreign markets

o long administrative procedures

o restrictive laws and regulations

Family Ownership:

The most important feature of family owned companies is their lack of separation between ownership and control. SMEs usually have the person who is a shareholder and a company executive at same time. There is no system of managing balance between shareholders and executives which leads to credibility problems. Usually in family-owned companies, family members have the power to dismiss any other executives or management or to reject their decisions and the usually want to have strong control over the day to day business. They see also any anything external to the family as a threat.

For this reason it is hard for them to go for external financing and usually depend on their personal savings. Other issues for family-owned businesses include (Gulzar and Wang, 2010):

� Lack of clear policies and long term planning because any policies and plans can be over-ruled at any time

� Lack of clear recruitment policy which encourage recruitment of family members over others despite of lack of skills and abilities for the organization

� Lack of clear compensation and benefits for family members

� Lack of succession planning

� Lack of the out of the box views on strategic decisions.

� Lack of exit strategies

Innovation requires clear path for the company, clear plans, and clear strategy towards all aspects related to the company. Also in order for innovation to be fruitful, SMEs should be ready for acquisitions, change of ownership structure at any time and also corporate governance must be controlling to increase credibility of the SME. SMEs are usually in developed countries are formed to build up an innovative idea or project then when it is ready for commercialization then ownership model changes with introduction of new Board,..etc. The usual ownership model in Egypt affects this path and is not creating the eco-system needed for innovation to spread. The Board management, formation,�etc are very important factors that affect the innovation and usually governed by the CG. That's why the family ownership style must be adapted using the corporate governance to be able to cover the loop holes that could affect the future of company innovative activity

Internationalization:

In developing countries, SME are facing fierce competition from domestic and international market competition (example the flood of low-cost Chinese products to Egyptian market). As levels of trade deficit go high in developing countries, the role of SMEs in exports is becoming more and more critical.

SMEs usually are more informal, dynamic and flexible which makes them in a better position to compete internationally through export strategy. The developing countries with cheaper labor cost can be very useful for export strategy.

In order for SME to be successful with their export strategy they must keep international linkages with target markets. Innovation is a key success factor in this strategy because it is one of the most important strategy components that would open doors for SMEs to export.

Access to international markets will help SMEs to gain exposure and see the importance of innovation.

For SMEs the internationalization is difficult for the following points(MOFT, 2004) , (UNDP,2005):

� Difficult Access to International Markets: SMEs usually have very narrow chances to export given the regulations, rules, customs,�etc which mostly can be handled by larger multinationals.

� Difficult Access to latest technology: The lack of technical skills needed for producing quality products and the lack of high-tech industry and entrepreneurs is a very obvious obstacle for SMEs. This is a major constraint to diversify especially in economics of developing countries which are relying on traditional exports such as agriculture, textile, natural resources etc. In the case of Egypt, most of exports are in the traditional fields which show the need to encourage innovation as a key strategy to build on traditional exports to increase the value added part and develop new innovative products. (Ministry of Foreign Trade The Small and Medium Enterprises Policy Development Project, 2003)

� Difficult Access to international investors: International investors are often hesitant to invest in developing countries because of fear to loose money due to the low level of security in terms of low enforcement of issues related to legal rights and governance framework. Larger companies will be interested to partner with SMEs only when there are levels of confidence and trust coupled with transparency and governance of the local partner. This is a major area of improvement which corporate governance and innovation frameworks can play a vital role to give the investors this level of confidence needed. Good Corporate governance may improve the internal control and management systems. This could result in more accountability and higher returns. This is attributed to improved review and evaluation which minimize chances for fraud losses and it also increase chances for attracting investors

� Insufficient knowledge of the foreign markets: SMEs are usually firms with a parochial reach and understanding of the markets. Most of them start as domestic firms with primarily a local market focus and very little knowledge about what takes place in markets beyond the national borders. The knowledge of foreign cultures, foreign social values and tastes as well as preferences is limited. And it is this lack of sufficient foreign markets which retards and impedes efforts to venture outside the domestic markets.

Agency Problems:

Agency problem are an inherent part of modern companies and it arises because the executives who manage the company are not the same individuals as the shareholders. As long as it is difficult or costly for the shareholders to monitor the executives, the executives will have an incentive to engage in behavior which maximizes their utility rather than the wealth of the shareholders (Matthew, 2011)

Agency problems may affect the corporate investment strategy however Shareholders have the ability to diversify away with high risks investment because they have the power to control the investment portfolio.

On the other hand, Executive's wealth in the form of salary, perquisites, and professional reputation is directly linked to company and that's why executives are usually risk averse than shareholders. Executives will usually prefer strategy low-risk/low-return assets over high-risk/high-return assets which puts their employment in danger. And the innovation strategy is always a high risk /high return route.

This gap creates what we call agency problems and corporate governance will determine the importance of these two different directions in determining corporate policy. This control of corporate governance over the agency problem may balance the executive views versus shareholders views in favor of risky investments in innovative activities.

The application of good corporate governance ensures there is enough time for shareholders to play their roles without being affected by any executive and administrative duties. This will decrease to conflicts especially in organizations owned by limited number of shareholders where the sharp line between ownership and management is not clear.

Thinking and Leadership Style:

Focus is on running the organization on a daily basis and therefore management finds little time to analyze and retain Innovation Competitive advantage. The focus is on getting the job done now. This style of management (which can be corrected using Corporate Governance practices) is characterized by issues of :

� Absence of planning and forward thinking

� Inadequate leadership and management skills at senior management level

� Lack of future business plans for development and sustainable growth as well as usually there is no new investment plans

� Problems with cash flows

� Inadequate access to technical assistance

These issues will hinder the ability to innovate and present new ideas for business development. Also it causes delays in coping with ever changing business environment and economic conditions which could be dangerous to existence of the company .If we think carefully about the main reasons why SMEs fail to exist, we find out that implementing good corporate governance practice may increase chances for these companies to perform well, grow and adopt improved decision making process. (El-Shobery, El-Iskandrani, and Hegazy, 2010)

1.6 WHY EMERGING MARKETS?

The definition of emerging market economy is directly linked to

1) The low to medium per capita income

2) Economic reforms and developments

3) Fast growth rate of economies

4) Moving from closed economy to open and global economy

Emerging markets form approximately 80% of the world population and they represent 20% of the global economy

China although it is one of the global economic powers it is falling under the category of emerging markets in addition to smaller economies like Tunisia. Both countries have economic reforms and have per capita income which is less than the more advanced economies.

Emerging markets are always striving to move to global system by building accountability transparency, efficiency in capital markets, confidence and trust in their companies. This need has created a very valid case for corporate governance.

In general these are the fundamental factors affecting corporate governance choices in emerging markets:

1) Compliance with low limits to an extent the level of corruption which gives more confidence to investors wishing to have shares in emerging markets but on the other hand this could increase the operating costs (Dallas, 2011).

2) The relationship between state or public ownership of companies and rewarding system for government officials is a key factor for success of corporate behavior. In china for example this has led to a better performance and in turkey it is the opposite. This is due to the different rewarding structures for government officers (Dallas, 2011). One of the studies conducted in the Indian context studied National innovation confirms the importance of corporate governance on innovation performance of Indian firms especially in the pharmaceutical industry. The study shows that since firms in India are mostly family owned then the motivation of family owners to invest successfully will affect innovation projects and consequently will affect the overall innovation of the country. Also the same rule applies on Short term investors even within financial institutions could affect the overall level of innovation. The study suggests legal provisions to discourage this systematic investor behavior (ASHWIN, 2011)

3) In countries where there are many protected sectors the competition is less which has a bad influence on corporate governance practice (Dallas, 2011)

4) In countries where companies are family owned the succession planning is usually linked to a family member not necessarily professional executives within the company. This presence of the family within board is sometimes positively affecting performance when relationships matter more such as in Thailand. In other markets such as in Korea it is the opposite and usually external individuals have positive effect on performance (Dallas, 2011)

5) Culture Context may affect the applicability of the Corporate Governance on the ground such as the case of Philippines where there are weak institutions. The capital market is also not fully mature and business environment are neither open nor transparent. Also in this context sometimes Corporate Governance is seen as a way of West imposing investor culture on the business mode (Del Rama, 2007). That�s why studying the culture context of developed countries is ultimately important to understand the business behavior and resistance to apply or localize it to the emerging markets needs

In the case of USA, a corporate is usually ruled by a board of directors, which has the power to choose top management, who are running the day to day operations of the corporate. Certain actions must be approved by the board such as recruiting his immediate deputy, raising funds, acquisitions, business expansion, or expensive and high risk innovative projects. In UK, they have a model called "comply or explain" for implementing governance which adopts some practices and recommendations for good corporate governance for listed companies. In this case, the listed companies must go for these practices or justify why they decided not to follow certain parts and mainly the monitoring is the responsibility of shareholders (Ahmed & Alam & Jafar & Zaman, 2008).

On the other hand, in the case of East Asian countries (Indonesia, Philippines, and Pakistan) we find that families are dominating 50% of state owned corporates and dominating capital markets. The same model is dominating Mexico, Brazil, Argentina and many countries in South America and in this case we have one major shareholder. Families in these countries have publicly traded companies in illiquid capital markets and there is a domination of families on corporations and institutions which magnifies the need for corporate governance (Ahmed & Alam & Jafar & Zaman, 2008)

CHAPTER TWO: LITERATURE REVIEW

2.1 INTRODUCTION

SMEs is usually referred to as the �engine room" of economy because of its potential to drive innovation and economic growth (Senator Hon Nick Sherry Assistant Treasurer 2009). It is the major employer in the Egyptian Economy private sector. They represent sixty five percent of all businesses.

Governance of small businesses is different from larger businesses due to the ownership structures, size and the nature of the day to day business management. In Egypt, the laws or regulation specifically tailored to governance of small businesses are non-existent and the evidence of impact of corporate governance on SMEs innovation is not established

Therefore, the aim of this study is to identify the corporate governance dimensions specific to small businesses that influence innovation.

2.2 CORPORATE GOVERNANCE OF SMEs

� Governance refers to the decision making and control of directions exercised by the boards of organizations and other related mechanisms outside the firm. In general, corporate governance is concerned with the structures and processes for decision-making, accountability, control and behavior at the top of organizations. As Kami Rwegasira (2000) summarily puts it, corporate governance is a set of systems, structures , processes and mechanisms by which a corporate entity is led , directed and controlled in the best interests of shareholders and other stakeholders .

2.3 WHAT IS THE DIFFERENCE BETWEEN CORPORATE GOVERNANCE FOR LARGE COMPANIES AND SMEs ?

o Numerous guidelines and standards for good governance have been developed aiming for good governance for the �big� corporations (Heenetigala & Armstrong 2010a). Corporate Governance is about how companies are managed and controlled by their boards of directors, the way supervision and accountability is achieved by those who direct and control the organization.

o In many SMEs this is the role of the owner/manager that's why in SMEs, corporate governance is therefore concerned with the respective roles of shareholders as owners and managers. This mix between roles is what makes SMEs unique.

o The Challenge in SMEs is about setting rules and procedures for a business, putting guidelines for auditing and balances in place to prevent abuse of authority, and ensuring the integrity of the financial results

o Also in large companies corporate governance is usually associated with agency theory due to the separation of ownership and management. The directors of a company are accountable to the owners and act as their agents in respect to management. In SMEs, quite often the owner is also the sole proprietor and the manager Thus, there is no separation of ownership and control and agency problems are less likely to exist.

o Furthermore, the question of accountability is not an issue in such SMEs businesses because they are not dependent on public funds and do not have to comply with any disclosures.

o Therefore, small businesses often consider corporate governance to be relevant only to larger corporations. However, good governance practices can have major advantages for all the companies, especially when there is a need to raise funds for expansion and also selling of the business.

o Good corporate governance practices are primarily not concerned with compliance with formal rules and regulations. It is about establishing a framework for processes and attitudes for a company, that add value to the business, help build reputation and also long-term success and

o Corporate governance is mainly concerned with improving performance and allowing the commensurate benefits to flow to stakeholders such as owners and employees. (Heenetigala & Armstrong & Clarke , 2011).

o Due to the particular characteristics of the SMEs the way they deal with issues relating to corporate governance are different to larger businesses. Many SMEs are not interested in growing �big� , but rather are focused on survival on a day to day basis and meeting expectations of providing their owners and their employees with a comfortable living that's why the absence of forward thinking can be sometimes a barrier to implement corporate governance

o Decision making refers to all those matters which affect the vision, performance and long term sustainability of an organization.

o The lean corporate governance structures in SMEs mean that decisions can be quickly made and implemented because in many SMEs only one or two persons, mainly the owners and/or managers, make the critical decisions to do with finance, accounting, personnel, purchasing, processing or servicing, marketing, selling without the aid of internal specialists and with specific knowledge in only one or two areas. For them corporate governance is the combination of views of the owners and the manner in which they wish to run the business.

o Most of the debate about corporate governance has focussed on the separation of the roles of Chairman and CEO, the appointment of independent directors, and more recently, the diversity of board members. The arguments for separation of the Chairman and CEO are drawn from agency theory. The argument is that there is a separation of ownership from control of companies leading to a conflict of interests between owners and managers. Based on the same theory is the requirement for the performance of boards to be assessed, and that this is a role for shareholders.

o As most SMEs are owner managed or family owned this argument is often irrelevant to SMEs, until their businesses have expanded to include second or even third generations of their families. Where agency theory could apply is when the business has a combination of inside owners and smaller outside investors. The minority shareholders could be disadvantaged if resources were hived off or directed to the advantage of the families and disadvantage of the other investors.

o Therefore, in relation to small businesses the application of stewardship theory is more appropriate. This theory proposes that managers are good stewards who will act in the best interest of the owners (Donaldson & Davis 1991). Therefore, the owner managers will act in the best interest of the company

o Independent boards and independent directors are seen as essential for achieving transparency and accountability in large companies. In SMEs companies, a board and independent directors are not regarded as a value but a cost to a business that cannot be afforded.

2.4 WHAT MAKES INNOVATIVE ORGANIZATION?

The traditional economics of innovation treats organizations as if they were alike and considers innovation as a direct consequence of profit-maximizing. On the other hand in the literature of corporate governance and innovation, it is recognized that firms differ in their internal structure and organization, and affirms that these differences do matter for a firm�s economic performance.

However, different approaches to the analysis of the firm propose various interpretations of the firm-internal context that enables innovation to be generated. Such different approaches, then, are at the base of the large variety of existing studies on corporate governance and innovation. Before presenting this body of studies, therefore, in this section we briefly discuss how the most influential theories of the firm deal with technological innovation, in order to outline the theoretical ground on which the debate on this issue develops.

Technological Innovation is generated through a process of learning, which needs the commitment of resources for a period of time. This process starts with the original product and through the utilization of resources, synthesis of knowledge a new forms can be generated and innovation evolves. By definition, technological innovation involves three key elements:

� Identification of the investments: Identifying investment required for the cumulative innovation process (Belloc,2010)

� The development of a new technology and innovation production is a risky process that involves interaction of knowledge and experience of innovators. The coordination and integration of these in response to technological and market problems then generates new knowledge and innovation evolve (Belloc, 2010). This is an exploratory process which may or may not succeed in generating new innovations which clearly shows the uncertainty (Belloc,2010)

� The commercialization of the generated innovation may not be possible that�s why Forecasting of any future returns is very difficult. Innovation process may result a new technology or product which is not sufficient or not a significant improvement of existing knowledge and its commercialization success is not guaranteed (Belloc,2010)

The above three elements show the uncertainty which makes it very difficult to develop comprehensive contracts that specify every stakeholder commitment. These elements usually cause a problem to raise funds which make it very difficult to take initial investment seed decision. Corporate governance can help with such situation by increasing clarity and decreasing the uncertainty. The following points state areas where corporate governance can help and how:

� Posting mechanisms can be largely improved by applying good Corporate governance practices which provides a partial solution to the problem

� Organization control can be improved to positively rectify organization�s innovation process by improving analysis and structures as well as focus of innovation efforts.

� In the presence of multiple investors, ambiguity, and personal interests; the corporate governance is the only successful path to ensure transparency and clarity on decision making process

� Corporate governance can help to institutionalize the arrangements governing the relationships between those who contribute to organization�s innovation and utilizing its assets and resources .

2.5 LINKING CORPORATE GOVERNANCE AND INNOVATION ?

The analysis of within-firm relationships between multiple investors can be roughly classified into three main groups:

� principal-agent paradigm (shareholders of the organization)

� incomplete contracting framework (stakeholders of the organization)

� Organizational Control Theory (which proposes a more general perspective).

These three approaches substantially define the basic theoretical ground for most of the studies on corporate governance and innovation. Corporate Governance studies related to Innovation show that :

� Based on the principal- agent paradigm, the agents (managers) are running the company on behalf of the principals (shareholders) (Jensen and Meckling, 1976).

� Based on the Stakeholders approach, business organizations might generate new knowledge by engaging all stakeholders who contribute to organization assets (Lazonick, 2003).

� Process and human assets are the main components that if utilized properly it will generate innovation. Based on this the Shareholders are not just investing money in physical assets but in these components which signifies the importance of the perspective of the stakeholders (Belloc, 2010).

� All Stakeholders have interests in company. This is could be for interest for the company or not. It could be a risky factor if everyone is running for his own show regardless of the whole landscape. That�s why any assessment of company�s innovation must consider the incentives related to all stakeholders who add value to the innovation process (Belloc, 2010).

� The problem of finding mechanisms or necessary governance that lead to greater levels of investment by all types of investors becomes central to the theory of innovation (Belloc, 2010).

� The best investment decisions can be realized when the assets are controlled by a passive third party that who manage the use of the assets, so removing the risk of hold-up between the different investors (Belloc, 2010).

� There are limitations for the stakeholder perspective. This is because innovation developed through process and utilizing certain assets may evolve with another set of assets in a different part of the same process. This could lead to obsoleteness of the original assets or it becomes not needed. As a result of that the power of stakeholder will diminish and this will contradict with investors� views who have participated in the past (Belloc, 2010).

� An innovative enterprise must achieve three social conditions in order to innovate (Lazonick,2007):

Financial commitment: the company must make sure that there is enough allocated money to the innovation process until it pays back with the proper financial returns.

Organizational integration: the company must develop rewards for the innovation project team members to encourage them to apply their skills and efforts to successful innovation process

Strategic control: The company empower decision makers to allocate all types of resources to fulfill the investment strategies and directions

� According to Schumpeter�s, the key innovative actors are the individual entrepreneurs, with the new and SMEs leading the process of �creative destruction�. SMEs, in this view, have the flexibility to adapt and adopt new things and overcome the larger companies' organizational inertia which can easily lead to breakthroughs.

� Innovation can be idea, practice, or object that is perceived as new knowledge or contribution or advancement or modification or a way of presenting or commercializing an existing knowledge by an individual or company. This shows the importance of investing in human capital as a strategic investment (Tiwari, 2007).

� Innovations usually take place as a result of a dynamic process in company that involves effective collaboration of several internal and external resources. This shows the potential of SME as a cornerstone for Research and Development (R&D) which forms the major part of the �innovation process� (Verworn et al, 2000/2006).

� Innovation may help firms their competitive position in their local markets as well as international markets which fosters innovation efforts as a mandatory component to bring edge to markets while developing organizational and manufacturing capacity for more efficient and cost effective production, distribution, sales and after sales services.