HomeChapter 1: The Introduction to This Study1.3 Alternative Approaches to the Formal Independence of Corporate Boards of Directors

1.3 Alternative Approaches to the Formal Independence of Corporate Boards of Directors

To align the interests between management, shareholders and other interest groups, Guthrie and Turnbull (1995:83) conclude that “ . . . various strategies are used by various cultures to bond the agents who process corporate information to those who use it.” The Anglo-Saxon and continental European approaches to board organization reflect these differences. As such, one-tier and two-tier board models can be seen as alternative organizational approaches to support the role of boards of directors to align the diverging interests of managers, shareholders and other stakeholders. The effectiveness of corporate boards to align these pluralistic interests is associated with the so-called formal independence of boards. The formal independence of corporate boards of directors can be conceptualized by Fama and Jensen’s (1983) distinction between the “decision management” and the “decision control” activities of corporate boards. Decision management refers to the tasks of executive directors to initiate and implement strategic decisions.

Decision control refers to the tasks of non-executive directors to ratify and monitor executive decisions. An independent board structure separates the activities of executive and non-executive directors. Seen from a more practical point of view, an independent board model minimizes the role of management in the ratification and monitoring of corporate decisions. As suggested by Davis (1991:73), “an independent structure is one in which an autonomous board of directors is established to monitor organizational strategic decisions and performance. [ . . .] Thus, in its purest form, management plays an extremely minor role in the independent structure.” Chapter two of this study further elaborates on the distinction between decision management and decision control.

 

Design Strategies of Board Organization

The concept of board independence is mostly essential to the shareholder perspective of corporate governance. This perspective is based on the assumption that the more independent directors are from management, the better they will serve the interests of shareholders. The influence of management on the board of directors can be reduced by at least three design strategies. First, corporations can modify their board leadership structures by securing that CEO and chairman roles are fulfilled by different individuals. An independent board leadership structure can be also supported by the appointment of non-executive lead directors to the board (see § 6.4.3. in chapter six). Second, the formal independence of corporate boards can be supported by the appointment of non-executive directors who have not been formerly affiliated with the corporation. Third, the formal independence of boards can be facilitated by the formation of board committees and the formal division of board roles through one or more hierarchical layers in the organization of the board (see also table 1.1).

 

Table 1.1

Design Strategies and the Formal Independence of Corporate Boards

 

  • Board leadership:
  • the separation of CEO and chair positions;
  • the appointment of lead directors.
  • Composition:
  • the appointment of a majority of non-executive directors;
  • the appointment of a majority of non-formerly affiliated non-executive directors.
  • Structure:
  • the separation of directors in management and supervisory boards;
  • the formation of independent oversight board committees.
 

 

The international corporate governance debate largely builds on the assumption that these design strategies improve the formal independence of boards. In addition, design strategies give rise to differences in the way one-tier and two-tier board models facilitate the formal independence of boards of directors. The next two paragraphs further elaborate on the formal independence of one-tier and two-tier boards.

 

The Formal Independence of One-Tier Boards

Directors who operate in Anglo-Saxon countries have been targeted by commentators, financial analysts, environmentalists, employees and investors to
apply design strategies that improve the formal independence of one-tier boards. In practice, business failures and excessive directors’ pay have put pressures on corporate boards to become more independently structured and composed of management. For example, stock exchanges that are fighting for a piece of the international financial pie are flexing their muscles to alter listing requirements that aim at changes in the formal organization of one-tier boards.

Regulators are continuously amending voluntary codes of best practices as well and are introducing guidelines to improve the formal independence of one-tier corporate boards. Especially one-tier boards with a majority of executive directors have been put under pressure to increase the number of independent non-executive directors. Another criticism is related to the practice of directors to combine the influential position of the CEO with the leadership of the board in one-tier boards (Boyd, 1995).

According to Sheridan and Kendall (1992:161): “There is an uncomfortable untidiness in having one group of directors supervising or controlling another group on the same board, which is meant to be the collective for managing the company.” Consequently, directors who operate with a board that is composed of a majority of executive directors who are also chaired by the CEO are under pressure to modify the composition and the structure of their boards in Anglo-Saxon countries.

 

The Formal Independence of Two-Tier Boards

A relatively new development in the debate on the formal independence of one-tier boards is the recognition that two-tier boards represent a board model that clearly separates executive directors’ management tasks from supervisory directors’ monitoring tasks. According to Tricker (1984) and Cadbury (1995), the two-tier board model represents a board structure in which the three design strategies are formally applied (see also table 1.1).

First, as previously noted, the two-tier board model has two organizational layers that separate the executive function of the management board from the monitoring function of the supervisory board. It is suggested by Sheridan and Kendall (1992) that the formal separation of these boards transparently defines responsibilities of executive managing directors and non-executive supervisory directors. Second, the supervisory board (the upper layer of the two-tier board) is entirely composed of non-executive supervisory directors, which secures an independent composition of the board (Pic, 1995). The management board is entirely composed of executive managing directors. Third, two-tier boards also provide a formal separation of CEO and chairman roles (Demb and Neubauer, 1992a). As such, decision management and decision control are formally separated in the two-tier board model.

The formal independence of one-tier and two-tier boards is indicated by figure 1.2. Arrow I in this figure suggests that the integration of decision management with decision control is negatively associated with design strategies applied to the composition, the leadership structure and the organization structure of two-tier boards. These board attributes are positively associated with the separation of decision management from decision control (arrow II). Figure 1.2 suggests also an opposite theoretical train of thought on the organization of one-tier boards.

 

Figure 1.2

The Formal Independence of Board Models

Arrow III suggests that common design strategies related to the attributes of one-tier boards are negatively associated with the formal independence of one-tier boards. In other words, while reformers seek independent board structures that clearly separate management tasks from boards’ monitoring tasks, design strategies related to the composition, the leadership and the structure of one-tier boards may facilitate the integration of decision management with decision control. This is indicated by arrow IV in figure 1.2.

These observations raise research questions on the formal independence of one-tier and two-tier board models. These are explored in more detail in paragraph 1.4.


Related news items:
Newer news items:
Older news items:

 
You may also be interested in these articles:

PDF Download

Interested in the PDF version of the study? Click here to download.

Maassen, G.F. (2002). An International Comparison of Corporate Governance Models. A Study on the Formal Independence and Convergence of One-Tier and Two-Tier Corporate Boards of Directors in the United States of America, the United Kingdom and the Netherlands.

Maassen, G.F. (2002). An International Comparison of Corporate Governance Models. A Study on the Formal Independence and Convergence of One-Tier and Two-Tier Corporate Boards of Directors in the United States of America, the United Kingdom and the Netherlands. Amsterdam: Spencer Stuart Executive Search.