The corporate governance literature recognizes different roles of boards of directors in decision making (Gopinath et al., 1994; McNulty and Pettigrew, 1996; Hung, 1998). The resource dependence theory and the stakeholder theory emphasize the resource allocation and boundary spanning roles of corporate boards. Theories originating from organizational economics, such as the agency theory and the legalistic approach, focus on boards’ roles to mitigate agency problems and to monitor management. The involvement of directors in the strategic course of the corporation is mainly understood by the stewardship theory.
Zahra and Pearce (1989), Gopinath et al. (1994) and Jonnergård et al. (1997) suggest that these theoretical schools recognize three generally accepted board role categories. These are the service roles, the control roles and the strategic roles of corporate boards of directors. The roles show similarities with the four decision making steps identified by Fama and Jensen (1983). The service roles, derived from the resource dependence theory and stakeholder theory, can be related to the decision management activities of the board. The control roles, as suggested by proponents of the agency theory and the legalistic approach to board organization, strongly focus on the decision control activities of the board. Daily (1991) indicates that these perspectives are not necessarily mutually exclusive. This is also indicated by table 2.1. This table shows that the strategic roles of corporate boards combine boards’ decision management and decision control activities. The integration of these roles is mainly understood by the stewardship theory.
Table 2.1 Examples of Theoretical Schools of Board Involvement
Decision management +
resource dependence theory;
The relationship between the service, control and strategic roles of boards of directors and the four steps in decision making are explored in more detail in the next sections of this paragraph.
Decision Management and the Service Roles of Boards of Directors
The service roles of boards of directors are predominantly recognized by the resource dependence theory and the stakeholder theory (Pfeffer 1972, 1973; Pfeffer and Salancik, 1978; Freeman and Reed, 1983; Kriger 1988; Boyd 1990; Boeker and Goodstein 1991; Wang, 1991). Within the context of these theories, corporate boards can perform at least the following four service roles:
- co-opting of external influencers;
- establishment of contacts (and the raising of funds);
- enhancement of the organization’s reputation, and;
- giving advice to organizations.
Source: Mintzberg (1983:81-86).
Central to the first service role is what is called the formal co-optation of organizations. According to Selznick (1966:13), co-optation is “. . . the process of absorbing new elements into the leadership or policy-determining structure of an organization as a means of averting threats to its stability or existence.” In their service role of co-opting external influencers, the board is seen as a device for corporations to secure linkages to various stakeholders in their business environments. The role of a co-opting board is one in which the organization uses the status of a board membership of the corporation. Its main purpose is to diffuse the power of important external influencers (Mintzberg, 1983). (2)
The second service role of boards of directors concentrates on the control corporations have over the availability of important external resources. Zald (1969:102) indicates that “ . . . a major source of board member control and influence stems from their control of crucial inputs of capital, raw materials or ‘market’.” Mintzberg (1983) suggests that this service role is all about making contacts between directors and the people they know to obtain and to secure critical resources of the corporation. Fund raising - for example - is an important function of corporate boards that coincides with the second service role of boards of directors. (3)
The third service role refers to boards of directors that play a role in enhancing or maintaining the reputation of corporations (Mintzberg, 1983; Demb and Neubauer, 1990). In this service role, boards of directors represent the firm's interest in the community and perform ceremonial functions. The board - for example - presides over shareholders' annual meetings and represents the corporation at press meetings and during other public activities (Pearce and Zahra, 1992). (4) The fourth service role suggests that boards of directors can also be actively involved in the formulation and implementation steps in decision making. According to Zahra (1990:109), “boards are expected to review and evaluate analyses and proposed changes. Specifically, boards may not develop new strategies but they may recommend making changes in company strategies.
Thus, directors may contribute to strategy development through careful refinements of strategic plans, by probing managerial assumptions about the firm and its environment, and by ensuring that agreement exists among executives on the strategic direction of the firm. (Accordingly, eds.) . . . strategy review represents the forum through which boards may influence the strategic process.” As such, the fourth service role of boards of directors may resemble the concept of decision management. Although the development of new strategies is the direct responsibility of management, the fourth service role may suggest that boards can serve management with their expertise through their involvement in the initiation and implementation steps in decision making.
Decision Control and the Control Roles of Boards of Directors
In contrast to theories on boards’ service roles, proponents of the legalistic perspective and the agency theory strongly emphasize the roles of corporate boards to monitor management and to represent the interests of shareholders. These perspectives of board involvement stress the responsibility of corporate boards to perform control roles as “independent sources of discipline” to align the interests of management with shareholders (Williams, 1979:15). In addition to other control agencies, the board is seen as a governance mechanism that can add value to a corporation by serving as an auditor or monitor of management (Demb and Neubauer, 1990). According to Johnson et al. (1993:35), control roles of boards concentrate on the control of agency problems and the promotion “ . . . of firm efficiency in order to maintain high levels of shareholder value.” Gopinath et al. (1994:177) define boards’ control roles as inwardly focused roles “ . . . wherein boards are expected to be watchdogs over management.” Weisbach (1988) - for example - emphasizes that corporate boards are the shareholders’ first line of defense against incompetent management. In extreme cases, it is the role of the board to replace the CEO and other executives to safeguard the interests of shareholders. The control roles of boards also include the responsibility of directors to select the CEO, to monitor his or her performance, to review CEO analyses and to ratify executive decisions (Tricker, 1984; Zahra and Pearce, 1989).
Mintzberg (1983) distinguishes the following roles boards can play in a control capacity:
- selecting the chief executive officer;
- exercising direct control during periods of crises;
- reviewing managerial decisions and performance.
Source: Mintzberg (1983:70-81).
Boards’ control roles are rather reactive in nature and imply post-factum assessment of management behavior (Demb and Neubauer, 1992b). According to Zahra (1990:109), this means that “the board should not be involved in developing or implementing strategy unless it firmly believes that the proposed strategy or its execution is wrong.” Of importance to this study is the observation that the control roles of boards of directors correspond with the concept of decision control. As suggested by Fama and Jensen (1983), the board of directors is the common apex of decision control to ensure the separation of decision management from decision control. As such, boards’ involvement strongly focuses on the independent ratification and monitoring of the initiation and implementation steps in decision making, the general supervision of management and the disclosure of information. Not surprisingly, the control roles of boards of directors are particularly advocated by proponents of independent board structures (Davis, 1991).
The Integration of Decision Management With Decision Control and the Strategic Roles of Boards of Directors
Proponents of the stewardship theory also recognize boards’ role in strategy (Donaldson and Davis, 1991; Gopinath et al. 1994; Boyd, 1995; Davis et al. 1997; Hung 1998). According to Zahra (1990:110), “ . . . boards need to go beyond their service and control function to participate actively in strategy.” Zahra’s observation suggests that boards’ strategic roles combine the service/decision management roles with control/decision control roles of boards of directors. As such, it can be observed that directors are far more actively involved in the initiation and implementation of decisions in addition to the ratification and monitoring of decisions when they perform a strategic role.
The integration of board roles is also observed by Mintzberg (1983) who states that it is not easy to untangle the service and control roles of boards in practice. He states: “ . . . how is one to know which role is really operative? Indeed, how can one distinguish, say, control from co-optation, or advice from contacts, when two or more roles can very well operate concurrently. In other words, at the margins the real purposes of the directors can be very subtly intertwined, discernible if at all only through intensive study of the actual behavior of board members” (Mintzberg, 1983:86).
As one of the strongest proponents of the strategic roles of directors, Andrews (1980:30) states that “a responsible and effective board should require of its management a unique and durable corporate strategy, review it periodically for its validity, use it as the reference point for all other board decisions, and share with management the risks associated with its adoption.” More authors have recognized the importance of the strategic roles of boards of directors. According to Sadtler (1993:113), “the board has a vital role in ensuring that corporate strategy is properly thought out and executed. It is a question that should be on every board agenda.” In essence, Gopinath et al., (1994:177) indicate that “ . . . when boards adopt a strategic role, the directors guide the definition of the corporate mission and are called upon to assist in the development, implementation and monitoring of the firm’s strategies.” Demb and Neubauer (1990:157) observe that “primarily through involvement in corporate strategy, boards can play a forward-looking role, adding value by utilizing its breath of experience.” These authors suggest that the involvement of directors in the formulation of strategy serves the following purposes:
- it helps non-executive directors to move along the learning curve regarding the industry – competitors, and the market – and technology;
- it subjects management proposals to the scrutiny of a broader-based set of perspectives. Questions posed by those with outside perspectives can lead to important modifications of corporate strategies;
- it prepares the board for implementation actions which might arise quickly. Without the anticipation provided through boards’ involvement in strategy, a promising acquisition which comes to the board as a surprise, might meet a cold response;
- it helps develop commitment and a sense of ownership of the corporate strategy among board members. The more the board understands management logic regarding the strategy, the more likely are discussions to be robust, constructive exchanges - rather than perfunctory sessions, or worse;
- a board which has been fully involved in the strategy process has much greater ability to play a critical role in top management succession than one which has been kept at greater distance.
Source: Demb and Neubauer (1990:158).
It can be observed that research on the strategic roles of boards mainly has focused on the context of overseeing or ratifying strategy, ignoring the possibility that boards can also be actively involved in the formulation of strategies. Yet, new evidence indicates that beyond acquiring resources through service roles and resolving or avoiding conflicts of interests through control roles, boards are increasingly involved in important decisions on strategy development, implementation and communication. Demb and Neubauer (1992) found in a European survey among 71 directors an increasing emphasis on the formation of strategy in corporate boards. Stiles and Taylor (1996) indicate that boards take a larger role in the development of strategy and in the discussion of competing choices in the UK.
In a recent study in nine countries, the Conference Board revealed that directors are spending more time on discussing their involvement in strategic assessment. Sixty percent of 82 participating corporations indicated that directors devote more time to strategy discussion. A greater role in strategy formulation was indicated by more than half the respondents while 49 percent described boards’ role as “actively engaged in the choice of strategic options” (Conference Board, 1996:7). According to Judge and Zeithaml (1992), the involvement of boards in strategic decision making is a result of the institutional response of corporations to external pressures. The authors indicate three “forces as catalysts for change”: litigation, pension funds and the market for corporate control (hostile takeovers). In addition, Zahra (1990) identifies five factors that call for more involvement of boards in the strategic area:
- boards play an important role as boundary spanners to link the corporation and its environment. Thus, they are in the position to gather relevant data that is vital to effective strategic actions by the corporation;
- directors’ expertise as managers in other corporations may prepare them to participate actively in the strategic process. Thus directors are often well acquainted with the demands of developing, changing or implementing strategies;
- rising shareholders’ activism compels directors to pay attention to strategy issues. Directors can no longer perform their fiduciary responsibilities without reflecting on the strategy in place;
- the complexity of the strategic process urges directors to participate. Armed with experience, a unique perspective, and a mandate to represent shareholders, directors must aid the CEO and top management in developing strategies that will maximize shareholders’ wealth;
- the complex competitive conditions companies face need to be recognized. Corporations are facing competition that is increasingly global in scope. Serious social problems are commanding the attention of executives. As a result, boards - through their total membership or specialized committees - can offer the CEO guidance on how to deal with these competitive and social conditions.
Source: Zahra (1990:111).
Competing Theoretical Perspectives of Board Involvement
The theoretical perspectives of board involvement in decision management and decision control are summarized in figure 2.2. The figure indicates that boards’ service roles have been recognized by proponents of the stakeholder theory and the resource dependence theory. Related to the fours steps in decision making (Fama and Jensen, 1983), it is suggested that the service roles of boards concentrate on activities related to the support of management and the initiation and the implementation of strategic decisions (decision management). The control roles of corporate boards of directors are mainly understood by theories originating from the organizational economics school, i.e. the agency theory and the legalistic approach to board organization. Boards’ control roles are mainly associated with the ratification and monitoring steps of the strategic decision making process (decision control). Figure 2.2 also indicates that the strategic roles of boards are recognized by the stewardship theory. The strategic roles focus on boards’ involvement in the initiation and implementation steps as well as the ratification and monitoring steps in the process of strategic decision making.
It is suggested that these theoretical perspectives of board involvement in strategic decision making can be divided in terms of conflict and consensus theories (Lammers, 1989; Bettis and Donaldson 1990; Jonnergård and Svensson, 1995). Conflict and consensus theories reflect on contrasting philosophies of management. According to Davis (1991), a conflict perspective of board involvement sees executive directors as self-serving agents who should be monitored. To support non-executive directors’ control roles, a conflict perspective of board involvement suggests that the formal organization of corporate boards should be designed in such a way that it clearly separates executive directors' involvement in strategic decision making from non-executive directors' involvement in monitoring. The agency theory is an example of a theory that is based on a conflict perspective of board involvement. Seen from this point of view, the debate on the separation of the CEO from the chairman of the board, the increasing appearance of non-executive directors in corporate boards and the formation of audit, remuneration and nomination committees with a majority of non-executive directors indicate the predominance of a conflict perspective of board involvement in the current corporate governance debate in Anglo-Saxon countries.
Theoretical Support of Board Roles in Decision Making
Consensus theories propose an opposite train of thought related to the roles and the organization of corporate boards. The stewardship theory represents a consensus perspective of board involvement. According to the stewardship theory, executive directors do not intentionally shirk and exert moral hazard (Jonnergård and Svensson, 1995). As such, it is a theory that strongly focuses on the empowerment of executive directors who are seen as honorable wealth builders. It is also a theory that seeks the integration of decision management with decision control through boards’ strategic roles (Donaldson and Davis, 1994).
Seen from this point of view, the stewardship theory opposes the notion that boards are devices to align conflicts of interest between shareholders and management. Boards are mainly seen as valuable strategic devices which should be built on integrative board structures that integrate decision management with decision control.
The Dilemma of Board Involvement
While the stewardship theory addresses the integration of board roles, proponents of a conflict perspective of board involvement foresee a potential conflict of interest when the four steps in decision making are put in the hands of directors (Charkham, 1986; Sheridan and Kendall, 1992). According to a conflict perspective of board involvement, non-executive directors should critically judge executive directors’ performance as part of the decision control role. Yet, the detachment and distance required to ensure that this judgment is independent and critical could be hindered by the integration of board roles (Demb and Neubauer, 1992a). As such, the integration of board roles could result in the dilemma of directors marking their own examination papers (Tricker, 1984). This dilemma is called the paradox of board involvement.
As previously indicated in chapter one of this study, design strategies that support the formal independence of corporate boards may hinder the strategic roles of boards; board roles that imply that directors are strongly involved in the initiation and implementation of strategic decisions besides the ratification and monitoring of strategic decisions. On the other hand, a formal board organization that supports the integration of decision management with decision control may hinder the control roles of directors. These are board roles that mainly concentrate on the ratification and supervision of corporate decisions. The next paragraph further reviews the literature on variables that may have a direct or an indirect effect on the involvement of directors in decision making and the way directors execute their service, control and strategic roles.
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