What makes great boards great

In the wake of meltdowns at WorldCom, Tyco, and Enron, enormous attention has been focused on the companies' boards. It seems inconceivable that business disasters of such magnitude could happen without gross or even criminal negligence on the part of board members. And yet a close examination of those boards reveals no broad pattern of incompetence or corruption. In fact, they followed most of the accepted standards for board operations: Members showed up for meetings; they had money invested in the company; audit committees, compensation committees, and codes of ethics were in place; the boards weren't too small or too big, nor were they dominated by insiders. In other words, they passed the tests that would normally be applied to determine whether a board of directors was likely to do a good job. And that's precisely what's so scary, according to corporate governance expert Jeffrey Sonnenfeld, who suggests that it's time for some new thinking about how corporate boards operate and are evaluated. He proposes thinking not only about how to structure the board's work but also about how to manage it as a social system. Good boards are, very simply, high-functioning work groups. They're distinguished by a climate of respect, trust, and candor among board members and between the board and management. Information is shared openly and on time; emergent political factions are quickly eliminated. Members feel free to challenge one another's assumptions and conclusions, and management encourages lively discussion of strategic issues. Directors feel a responsibility to contribute meaningfully to the board's performance. In addition, good boards assess their own performance, both collectively and individually.     

Columbia Law School Roundtable on A Governance Research Agenda for the Academy

Since Jensen and Meckling's formulation of the theory of “agency costs” in 1976, corporate finance and governance scholars have produced a large body of research that attempts to identify the most important features and practices of effective corporate governance systems. But for all the research that has been done in the past 40 years, many practitioners continue to see a disconnect between theory and practice, between the questions researched and the questions that need to be answered. In this roundtable, Martijn Cremers begins by challenging the conventional view that limiting “agency costs” is the main challenge confronted by boards of directors in representing shareholder interests and, hence, the proper focus of most governance scholarship. Especially in today's economy, with the high values assigned to growth companies, the most important function of corporate governance may instead be to overcome the problem of American “short termism” that he attributes to “inadequate shareholder commitment to long‐term cooperation.” And he buttresses his argument with the findings of his own recent research suggesting that obstacles to the workings of the corporate control market like staggered boards and supermajority voting requirements may actually improve long‐run corporate performance by lengthening the decision‐making horizon of boards and the managements they supervise. Vik Khanna discusses Indian Corporate Social Responsibility (CSR) spending and its effects in light of a recent law requiring Indian companies of a certain size to devote at least 2% of their after‐tax profit to CSR initiatives. One unintended effect of this mandate, which took effect in 2010, was that all Indian companies that were spending more than the prescribed 2% of profits cut their expenditure back to that minimum, suggesting that CSR and advertising are substitutes to some extent, and that such legal mandates can discourage CSR spending by early adapters or “leaders.” Nevertheless, Khanna also found evidence of social norms developing in support of CSR, including a spreading perception that such spending can help some companies achieve strategic goals. Jeff Gordon closes by arguing that, to the extent investors are short‐sighted, their short‐sightedness is likely to be justified by their recognition that public company directors have neither the information nor the incentives to do an effective job of monitoring corporate managements. The best solution to the problems with U.S. corporate governance is to replace today's “thinly informed” directors with “activist” directors who more closely resemble the directors of private‐equity owned firms. Such directors would spend far more time with, and be much more knowledgeable about, corporate management and operations—and they would have much more of their personal wealth at stake in the form of company stock.     

The effectiveness of chief financial officer board membership in improving corporate investment efficiency

The key roles of the Chief Financial Officer (CFO) in firm operating performance, corporate strategic choices, and corporate governance have been increasingly emphasized in recent decades. In this study, we empirically investigate the relation between CFO board membership and corporate investment efficiency to determine whether CFO presence on the board reduces firms’ propensity to over- or underinvest. We find that CFO board membership is significantly associated with a decreased level of corporate over- and underinvestment. Further, the positive effects of CFO board membership on corporate investment efficiency are greater for firms with greater information asymmetries. Last but not least, we find that the improved investment efficiency experienced by firms with CFOs on their boards has a positive effect on the firms’ future performance. Overall, we find that CFO board membership is associated with improved investment efficiency and firms’ future profitability. By documenting the real business impact of CFO board membership on investment efficiency and firms’ future performance, we add bricks to the literature on board composition and how it influences firms’ strategic choices and performance. Our findings suggest that having CFOs on boards could benefit firms’ investment practices, which directly relate to corporate strategic performance.

     

Board 3.0: What the Private‐Equity Governance Model Can Offer Public Companies∗

The authors view board structures as an adaptive institution that responds to the key challenges faced by public companies: helping management solve the problems of production and organization of large‐scale enterprise; limiting managerial agency costs; serving as a delegated monitor of the firm's compliance obligations; and responding to the governance environment of changing shareholder ownership patterns. U.S. company board structures are shown to have evolved over time, often through discontinuous lurches, as particular functions have waxed and waned in importance. This article is part of a larger project that traces two iterations of the public company board, what the authors call Board 1.0 (the “advisory board”) and Board 2.0 (the “monitoring board”). The authors argue in particular that Board 2.0, as embedded in both current practice and regulation, now fails the functional fit test for many companies. First, it does not scale to match the dramatic increase in the size and complexity of many modern public corporations. Second, at a time of reconcentrated ownership achieved through institutional investors and increased activism, it does not have the expertise and commitment needed to resolve the tension between managerial or market myopia, or “short‐termism,” and managerial “hyperopia.” This article holds out an optional alternative, Board 3.0, which would bring to the public company board some strategies used by private equity firms for their portfolio company boards. Such “Portco” boards consist of directors who are “thickly informed,” “heavily resourced,” and “intensely interested.” Bringing such “empowered directors” to public company boards could facilitate evolution of the public company board model in response to dramatic changes in the corporate business environment. The authors also suggest possible routes for implementing Board 3.0, including the enlisting of PE firms as “relational investors” that would have both capacity and incentives to engineer changes in board structure.     

The Labor Market for Directors and Externalities in Corporate Governance

This paper studies how directors' reputational concerns affect board structure, corporate governance, and firm value. In our setting, directors affect their firms' governance, and governance in turn affects firms' demand for new directors. Whether the labor market rewards a shareholder‐friendly or management‐friendly reputation is determined in equilibrium and depends on aggregate governance. We show that directors' desire to be invited to other boards creates strategic complementarity of corporate governance across firms. Directors' reputational concerns amplify the governance system: strong systems become stronger and weak systems become weaker. We derive implications for multiple directorships, board size, transparency, and board independence.     

Corporate Governance and the Cost of Capital: Evidence from Australian Companies

The authors examine a sample of large Australian companies over a 10‐year period with the aim of analyzing the role that firm‐level corporate governance mechanisms such as insider ownership and independent boards play in explaining a company's cost of capital. The Australian corporate system offers a unique environment for assessing the impact of corporate governance mechanisms. Australian companies have board structures and mechanisms that are similar in design to Anglo‐Saxon boards while offering a striking contrast to those of German and Japanese boards. At the same time, however, the Australian market for corporate control is much less active as a corrective mechanism against management entrenchment than its U.S. and U.K. counterparts, making the role of internal governance mechanisms potentially more important in Australia than elsewhere. The authors report that greater insider ownership, the presence of institutional blockholders, and independent boards are all associated with reductions in the perceived risk of a firm, thereby leading investors to demand lower rates of return on capital. In so doing, the study provides evidence of the important role of corporate governance in increasing corporate values.     

Strategic Governance and Management Accounting: Evidence From a Case Study

This paper seeks to establish if top management (the board) of a firm should extend its overview of the governance process to the execution of strategy (i.e., strategic governance) and, if so, does the management accounting information system (MAIS) have a role in facilitating this strategy execution process. This study investigated the role of the board and MAIS in strategic governance by examining a company with a public record of both successful governance and integrated strategic management accounting processes in a high‐risk industry. The analysis demonstrates that boards should go beyond the minimum conformance (compliance) requirements of the governance‐regulatory legislation and assume ultimate responsibility for strategy execution and enterprise performance. However, while management accounting techniques, processes and reports were found to be used extensively in strategic governance to integrate the policy‐management interface in numerous conformance–performance domains, the traditional role of the management accountant was found to be limited in terms of their role in such governance. The study demonstrates that a more strategic governance role offers the management accountant a way back into senior management by using the routines of management accounting to socialize the board and curb any opportunism that may arise.     

THE ACTIVE BOARD OF DIRECTORS AND ITS EFFECT ON THE PERFORMANCE OF THE LARGE PUBLICLY TRADED CORPORATION

In recent years, boards of directors have become more active and independent of management in pursuing shareholder interests. But, up to this point, there has been little empirical evidence that active boards help companies produce higher rates of return for their shareholders. In this article, after describing the new board activism, the authors argue that past failures to document an association between independent boards and superior corporate performance can be explained by two features of the research: its concentration on periods prior to the 1990s (when most boards were largely irrelevant) and its use of unreliable proxies (such as a minimum percentage of outside directors) for a well-functioning board.
The authors hypothesize that an independent and resourceful board takes steps that require management to increase earnings available to investors. To test this hypothesis, the performance of a sample of large U.S. corporations was examined over the period 1991-1995 using two proxies for the "professionalism" of each company's board: (1) the letter grades (A+ to F) assigned by CalPERS for corporate governance; and (2) a "presence" or "absence" grade based on three key indicators of professional board behavior. Both of these governance metrics were associated in statistically significant ways with superior corporate performance, as measured by earnings in excess of cost of capital and net of the industry average. While acknowledging that such results do not prove causation, the authors conclude that, in the first half of the 1990s, corporations with active and independent boards added significantly more value for shareholders than those with passive, "rubber-stamp" boards.     

Bank Corporate Governance,Beyond the Global Banking Crisis

Following up on the publication of the Walker Report ( 2009 ) in the United Kingdom, international organizations such as the Basel Committee ( 2010 ), the OECD ( 2010 ), and the European Union ( 2010 ) have proposed guidelines to improve bank corporate governance and, more specifically, risk governance. These international reports vary widely on what the prime objective of bank corporate governance should be, with one group recommending a shareholder‐based approach, and the other a stakeholder‐based one. Moreover, the focus of these reports is exclusively on risk avoidance, with little guidance as to how an acceptable level of risk should be defined. Drawing on insights from economics and finance, this paper is intended to contribute to the debate on bank corporate governance. Our four main conclusions are as follows. Firstly, the debate on bank governance should concern not only the boards but also the governance of banking supervision with clearly identified accountability principles. Secondly, since biases for short‐term profit maximization are numerous in banking, boards of banks should focus on long‐term value creation. Thirdly, board members and banking supervisors should pay special attention to cognitive biases in risk identification and measurement. Fourthly, a value‐based approach to risk taking must take into account the probability of stress scenarios and the associated costs of financial distress. Mitigation of these costs should be addressed explicitly in the design of bank strategy.     

How do female directors improve board governance? A mechanism based on norm changes

Prior literature documents that corporate boards with female directors produce better governance outcomes than all-male boards. However, female directors constitute the minority on most boards, which precludes majority voting as the mechanism through which they change board decisions. We identify changing the norms of how the board works as this mechanism. Using the market for norms framework, we explain how female directors are effective even without possessing a board majority or other sources of symbolic power, such as hierarchical authority and social gravitas. Empirically, we show that independent female directors, compared to their male counterparts, are more effective at changing board norms (board processes) and improving governance (board outputs).     

Managing the “S” in ESG: The Case of Indigenous Peoples and Extractive Industries

Although a company's “social license to operate” is critical to its long‐run viability and success, the “social” component of corporate environmental, social, and governance (ESG) problems appears to be taking the longest to be integrated into the corporate business model. The authors make the case that corporate boards must assume a more direct and proactive role in identifying, measuring, and mitigating social risk. Board involvement in the management of social issues, although not a silver bullet by itself, is an important step that can help catalyze the changes needed within upper, middle, and lower management. The absence of board oversight of social performance means that the reporting chain is not reaching the highest level of management. And this in turn creates a lack of attention and accountability to social performance that is likely to permeate the rest of the company. Along with board oversight, companies need more and better information to understand the value that good social performance creates for business, and to equip them for building and maintaining positive relationships with communities. At the individual company level, this means more comprehensive and granular analysis of social risk, the full range of costs of conflicts with local communities, the benefits of having a social license, and quality baseline data for community engagement. At the macro level, these data points must be aggregated to understand their implications across industries.     

The new work of the nonprofit board

Too often, the board of a nonprofit organization is little more than a collection of high-powered people engaged in low-level activities. But that can change, the authors say, if trustees are willing to discover and take on the new work of the board. When they perform the new work, a board's members can significantly advance the institution's mission and long-term welfare. Doing the new work requires a board to engage in new practices. First, the board must go beyond rubber-stamping management's proposals and find out what issues really matter to the institution. It can do that by making the CEO paint the big picture of the organization's strategic concerns, by understanding key stakeholders, by consulting experts, and by deciding what needs to be measured in order to judge the institution's performance. Second, a board doing the new work must take action: the board must not only set policy but also work with management to implement it. Third, the board must go beyond strictly functional organization: the new work requires flexibility and encourages ad hoc arrangements. Finally, board meetings--where boards underperform most visibly--should be driven by goals, not by processes. The authors give many examples of boards that have successfully embraced the new work. The stakes are high: if boards demonstrate that they can change effectively, the professional staff at the institutions they serve just may follow suit.     

Do co-opted boards strategically choose LGBT-supportive policies?

This study contributes to the underexplored literature: corporate governance responsibilities towards internal stakeholders (the employees). We investigate (a) whether the co-opted board, that is, the proportion of directors appointed after the current CEO takes office, influences firms' adoption of Lesbian, Gay, Bisexual and Transgender (LGBT)-supportive policies, (b) if so, what motivates the co-opted boards to do so, and (c) how these relationships change at times of limited economic resources and heightened governance. Based on 4850 firm-year observations of 1081 firms over the sample period of 1996–2010, we find (a) firms with co-opted boards are more inclined towards LGBT-supportive policies, that address stakeholders internal to the firms, (b) management of co-opted boards that adopt LGBT-supportive policies experience a higher increase in compensation than management of co-opted boards that do not adopt LGBT-supportive policies, and (c) during the global financial crisis (GFC), when firms aimed to survive economically under tighter governance, co-opted boards have lower tendency to adopt LGBT-supportive policies. This study offers insights to regulators interested in promoting board structures that address stakeholders. Despite the positive benefits documented in the literature on inclusive policies such as LGBT-supportive policies, the adoption of such policies may have a dark side to it.     

Does Effective Corporate Governance Facilitate Continuous Market Disclosure?

The focus of this study is the role of corporate governance in ensuring exchange listed companies meet their continuous disclosure (CD) obligations. In doing so it attempts to address a deficiency in the generic corporate disclosure literature by investigating the ability of corporate governance to ensure quality corporate disclosure. Despite acknowledging that disclosure is adversely affected by agency conflict and that corporate governance is an effective control of that conflict, few studies have attempted to provide empirical evidence of a link between corporate governance and corporate disclosure quality. The results of this study show that a company's corporate governance does impact on its CD performance. In particular, it provides evidence that the likelihood of a company failing its CD obligations decreases as the proportion of independent directors on the board increases. This likelihood also decreases for firms that segregate the roles of CEO and board chair. In addition, the study also shows that declining company profitability increases the risk of CD failure. These results provide an important link between the corporate governance literature and the disclosure literature. The results of this study should provide regulators and company stakeholders with evidence to continue to demand corporate governance improvements as an important tool in improving market efficiencies.     

An Analysis of Changes in Board Structure during Corporate Governance Reforms

This study examines the evolution of company board structure during a period of corporate governance reform. Using data over a time period following the publication of the Cadbury Report (1992) we present evidence of an increase in the independence of UK boards, as measured by an increased willingness to employ independent non‐executive directors, and to separate the positions of the CEO and the Chairman of the Board. In examining the determinants of these changes, we find that boards change more readily in response to changes in managerial control, equity issuance and corporate performance than changes in the firm‐specific operating environment of companies.     

What Drives CEOs to Take on More Risk? Some Evidence from the Laboratory of REITs

Many have pointed to excessive risk‐taking by the CEOs of financial firms as a contributor to the recent worldwide economic crisis. The same observers often blame questionable corporate governance structures and compensation practices for that risk‐taking. But is this perception correct? And what is the relationship between CEO incentives and risk‐taking outside of the financial industry, where the government guarantees provided by deposit insurance could have distorted incentives? In an attempt to answer these questions, the authors analyze the relationship between CEO incentives and corporate risk‐taking by 101 U.S. REITs during the period 2003 to 2007. Their main finding is that corporate risk‐taking, as measured by the growth rate in corporate debt (the only measure of risk that is completely under the control of the CEO), is inversely related to CEO stock ownership—that is, the larger the CEO's equity ownership stake, the slower the growth in debt financing and financial risk‐taking. At the same time, the authors find that financial risk‐taking is positively related to large cash bonuses for the CEOs and to situations in which the CEO is also chairman of the board of directors. Finally, the authors also report that CEOs who are relatively new to the job grow more slowly and borrow less, suggesting that boards of directors can temporarily contain risky expansion plans by the CEO. These results provide support for those corporate governance reformers who wish to cut cash bonus payments for CEOs in favor of long‐term stock ownership.     

New Corporate Forms: One Viable Solution to Advancing Environmental Sustainability

There is a clear trend in corporate governance toward increased attention to the environmental and social impacts of business operations. Major consulting firms are advising Fortune 500 companies on how to become more environmentally sustainable, private equity and “impact” investors are measuring environmental, social, and governance (ESG) factors, and voluntary reporting and shareholder resolutions on issues of environmental sustainability are on the rise. While traditional corporate forms allow companies to embrace social and environmental responsibility with some measure of success, various real and perceived risks encourage directors to focus on short‐term profitability. Even if a company has a strong social mission at inception, founders often have difficulty “anchoring their mission” over time. And the lack of required disclosure of social and environmental performance makes it more difficult for investors to evaluate and compare companies. Many believe that the institutionalized mispricing of natural resources and the continued failure to price externalities, combined with the progressive nature of climate change, require the transformation of both business and law. This article discusses social and environmental sustainability within the traditional corporate form and then explores three emerging alternatives that are now being used by businesses in California: limited liability corporations (LLCs); benefit corporations (B corps); and flexible purpose corporations (FPCs). Of these three alternatives, FPCs—a corporate form that requires shareholders to agree on one or more social missions with management and the board—may be best suited to meet the needs of the many small private firms (as well as some large public companies) that, whether for purely economic or altruistic reasons, plan to integrate ESG into their operations.     

The One.Tel Collapse: Lessons for Corporate Governance

One.Tel was a major corporate collapse in Australia in 2001. At the time of its collapse, it was the fourth largest telecommunications company in Australia with more than two million customers and operations in eight countries. Analyses of quantitative and qualitative data from diverse sources suggest that One.Tel's collapse is a classic case of failed expectations, strategic mistakes, wrong pricing policy, and unbridled growth. The company's meteoric rise and fall was associated with serious deficiencies in its corporate governance, including weaknesses in internal control, financial reporting, audit quality, board's scrutiny of management, management communication with the board, and poor executive pay‐to‐performance link. Thus, the collapse of One.Tel has several important lessons on the role of corporate governance in preventing corporate collapse.     

Board structure and corporate risk taking in the UK financial sector

This paper examines the relationship between board structure and corporate risk taking in the UK financial sector. We show how the board size, board independence and combining the role of CEO and chairperson in boards may affect corporate risk taking in financial firms. Our sample is based on a panel dataset of all publicly listed firms in the UK financial sector, which includes banks, insurance, real estate and financial services companies over a ten year period (2003 − 2012). After controlling for the effects of endogeneity through the application of the dynamic panel generalized method of moments estimator, the findings of this study suggest that the presence of non-executive directors and powerful CEOs in corporate boards reduces corporate risk taking practices in financial firms. The negative relationship can be explained within the agency theory context, where managers are regarded as more risk averse because of the reputational and employment risk. An increased power concentration is therefore expected to enhance the risk aversion behaviour of directors. The findings however, do not show any significant effect of board size on corporate risk taking in financial firms. As this study covers recommendations of the UK Corporate Governance Code on the role of corporate boards in managing firms' risk, the empirical evidence could be useful for corporate governance regulation and policy making.     

Corporate board and board committee independence,firm performance,and family ownership concentration: An analysis based on Hong Kong firms

This study examines whether the relationship between corporate board and board committee independence and firm performance is moderated by the concentration of family ownership. Based on a sample of Hong Kong firms, we find no significant association between the independence of corporate boards or board committees and firm performance in family firms, whereas board independence is positively associated with firm performance in non-family firms. Additionally, our findings show that the proportion of independent directors on the corporate boards of family firms is lower than that of non-family firms, but we find no significant difference in the representation of independent directors on the key committees of corporate boards between family and non-family firms. Overall, these results suggest that the “one size fits all” approach required by the regulatory authorities for appointing independent directors on corporate boards may not necessarily enhance firm performance, especially for family firms. Thus, the requirement to appoint independent directors to the corporate boards of family firms needs to be reconsidered.