HomeChapter 3: Boards - Conflict Perspective3.3 A Conflict Perspective of One-Tier Board Model Attributes

3.3 A Conflict Perspective of One-Tier Board Model Attributes

Not all scholars are sympathetic to the view that corporate boards effectively monitor managerial behavior (Mace, 1971; Herman, 1981; Vance, 1983; Daily, 1991). Given the international call for reform, proponents of a conflict perspective of board organization strongly emphasize that one-tier boards are not independent enough. As indicated by Zald (1969:98): “ . . . some scholars have doubted whether the formal system of board control does any more than provide lip service to the law. Those who argue that boards of directors are merely a legal and co-opted appendage believe organizations are controlled by the full-time managers . . . They believe boards are at the mercy of the managers who control information, definitions of alternatives, the nominating process, and, indeed, the very agenda of decision making.”

Sundaramurthy et al. (1996) indicate that corporate boards historically have been relatively ineffective and passive. Some authors even indicate that ineffective boards are no more than ceremonial rubber-stamping devices to support the objectives of management (Rechner and Dalton, 1991). The observation that directors not always act in the best interests of shareholders has resulted to many initiatives from legislators, exchanges, institutional investors and other boardroom reformers who recommend changes in the formal structure of one-tier boards in the US and the UK. As summarized by Wang (1991:3): “Over the years, numerous recommendations of boardroom reform have been proposed. Some of the recommendations call for separating the position of the CEO and chairman, redefining directors’ constituent responsibilities, reducing the number of directors, asking all insiders on the board other than the CEO to resign, requiring directors to own a substantial amount of stocks relative to their compensation, and redefining precisely what directors should or should not do as well as establishing criteria for board evaluations . . .”

That does not mean that all one-tier boards are associated with ineffective boards. Yet, related to the formal organization of one-tier boards, criticism is particularly addressed to the composition of boards when these are dominated by executive directors and when directors combine board leadership positions with executive responsibilities in one-tier boards. The criticism related to these attributes of board organization and the formal independence of one-tier boards are discussed in more detail in the remaining parts of this paragraph.

 

One-Tier Board Composition

It is suggested that the division of board roles between executive and non-executive directors is troubled in one-tier boards models due to the diffusion of tasks and responsibilities of directors (Sheridan and Kendall, 1992). In the US and UK, corporation laws - for example - do not make a distinction between the role and position of executive and non-executive directors. Non-executive directors have the same legal responsibilities and are confronted with the same legal liabilities as their executive colleagues. The division of board roles in one-tier boards is further troubled by the common practice of directors to compose their boards with a majority of executive directors. Corporate boards composed of a majority of executive directors are frequently associated with structures in which potential conflicts of interest can arise between management and shareholders. Sheridan and Kendall (1992:161) indicate that 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.” Charkham (1994:334) concludes: ”If it is desired to put and end to fudge, the logic is to differentiate between the duties of supervisors and the managers.” As such, proponents of a conflict perspective of board organization indicate three main reasons why one-tier boards should be composed of a majority of non-executive directors. Corporate boards should be predominantly composed of non-executive directors because of the:

 

  • breadth of their experience and knowledge;
  • contacts they have which may enhance management’s ability to secure external resources;
  • independence they have from the CEO. Non-executive directors are considered better able to provide independent assessment of actions taken by the firm and insure that there are proper checks and balances on management.

Source: Kesner and Johnson (1990:328).

 

These observations suggest that one-tier boards, dominated by executive directors, are negatively associated with the formal independence of corporate boards. This observation is formalized by the following assumption on one-tier board model composition and the formal independence of corporate boards:

 

Based on a conflict perspective of board organization, assumption 1a reads: one-tier boards composed of a majority of executive directors are negatively associated with the separation of decision management from decision control.

 

Empirical evidence suggests support for the wide-spread belief that one-tier boards dominated by executive directors are negatively associated with the independence of corporate boards and ultimately with the performance of corporations. Kosnik (1987) investigated 53 greenmail-paying corporations and 57 corporations that resisted the payment of greenmail between 1979 and 1983. The author found that corporate boards that resisted the payment of greenmail (the private repurchase of company stock at a premium above the market price to secure its control position when faced with a raider – Kosnik, 1987) have a higher proportion of non-executive directors than boards that did not resist the payment of greenmail. Weisbach (1988) investigated 367 corporations listed on the New York Stock Exchange between 1974 and 1983.

The author found that “outsider-dominated” boards tended to add firm value through CEO changes. Boards with at least 60 percent of nonaffiliated non-executive directors were significantly more likely to remove the CEO when the corporation was confronted with a poor performance than corporations that did not have a board dominated by non-executive directors. A study of Schellenger et al. (1989) indicated a positive relationship between the proportion of non-executive directors in boards and the financial performance of 526 corporations. Rosenstein and Watt (1990) found in a sample of 1251 appointments of non-executive directors a significantly positive stock price reaction after corporations announced the appointment of non-executive directors. Kesner and Johnson (1990) investigated a total of 53 Delaware corporations that were sued by their shareholders between 1975 and 1986.

Compared to a control group of 53 other Delaware corporations, the results of the study indicate that boards that were sued for violation of their fiduciary duties had a greater number of executive directors than boards that were not sued for these violations. Yet, the authors did not reveal a significant relationship between the composition of the board and suit outcomes. Beasley (1994) examined the relationship between the composition of boards of directors and the occurrence of management fraud. Based on a sample of 150 publicly traded corporations in the US, the author found that in the period between 1980 and 1991 board composition significantly affected the likelihood of financial statement fraud. Firms that experienced no management fraud were significantly more likely to have higher percentages of non-executive directors on their boards than corporations that were confronted with fraud.

Baysinger and Butler (1985) indicated in their study of 266 corporations that nonaffiliated non-executive directors had a positive effect on the average return on equity. Yet, the authors found a lagged effect of board composition on firm performance. Pearce and Zahra (1992) also found a positive association between board composition (the high representation of non-executive directors) and future measurements of corporate financial performance.

          

One-Tier Board Leadership Structure

In addition to the composition of corporate boards, another central topic in the discussion on the formal independence of corporate boards is the leadership structure of one-tier boards. Seen from both practical and theoretical perspectives of board organization, it is suggested that the decision control task of the board to monitor and to discipline management is weakened when the CEO and the chairman positions of the board are combined (Mulick, 1993). As suggested by Kesner and Dalton (1986, quoted in: Rechner and Dalton, 1989:141): “A potential threat to the independence of the board is the dual role of CEO as chairperson . . . The top managerial officer in the corporation . . . is also the chairperson of the group that is chartered, among other things, to monitor and evaluate the top managerial officer. Isn’t reasonable to expect that, as board chairperson, the CEO would attempt to influence other board members? . . . An analogous potential for abuse would exist if the President of the United States served simultaneously as Chief Justice of the Supreme Court.” According to Sheridan and Kendall (1992), CEO-duality (the combination of chairman and CEO roles) creates a diffusion of board roles and an erosion of the non-executive directors’ decision control role. Dalton and Kesner (1987:35) also state: “A very real threat to the exercise of independent judgement by the board of directors is the dual role of CEO as board chairperson.” Dahya et al. (1996) indicate that a dual board leadership structure may even eliminate systems of checks and balances in the boardroom. According to these authors, there are five main arguments in favor of separating the roles of chairmen from the CEO in one-tier boards:

 

  • there is said to be a conventional belief - well supported in the literature on corporate governance - that the chairman should be independent and that his independence will help to provide a measure of balance to the board and also supply a useful check on the possibly over-ambitious plans of the CEO;
  • a move to a dual CEO top management structure is likely to be interpreted by investors as an adverse signal and may result in a fall of the share price of the corporation. Stock market reactions of this nature are likely to be significant if it is believed that someone who holds the two top positions is likely to pursue strategies which advance their personal interests to the detriment of those of the firm as a whole;
  • a move to a dual CEO structure may eliminate an important check on the actions of the chief executive which could place the corporation at risk;
  • an independent chairman may provide a valuable “outside” perspective, perhaps has contacts in government or finance which are useful to the corporation and, if a member of other boards - as is often the case - can offer insights or comparisons derived from personal knowledge of other organizations;
  • studies present evidence that the profitability of corporations is significantly enhanced when there is an independent chairman.

Source: Dahya et al. (1996:72-73).

 

The agency theory suggests that due to the assumed opportunistic behavior of the CEO and other executives, a concentration of power and strong leadership is expected to result to sub-optimal top management behavior. As such, there is a strong consensus in the agency literature that one-tier boards should be directed by independent non-executive chairmen. According to Dalton et al. (1998:271): “ . . . there is a strong sentiment among board reform advocates, most notably public pension funds and shareholder activists groups, that the CEO should not serve simultaneously as chairperson of the board . . .” The following assumption reflects the idea that CEO-duality in one-tier boards does not support the formal independence of the board:

 

Based on a conflict perspective of board organization, assumption 1b suggests: CEO-duality in one-tier boards is negatively associated with the separation of decision management from decision control.

 

Rechner and Dalton (1991) examined the relationship between the existence of CEO-duality and the financial performance of 250 randomly selected Fortune 500 corporations between 1978 and 1983. The study indicates that firms, opting for independent leadership, outperform firms relying on CEO-duality in terms of return of equity, return on investment and profit margin. Mallette and Fowler (1992) found an association between CEO-duality and the incidence of poison pill adoption in a sample of 673 manufacturing firms (poison pills are contingent securities that impose financial burdens on acquirers when triggered by change of control events – Malec, 1995). The study indicated that corporations with a dual board leadership structure are more likely to pass poison pills than corporations that have the CEO and chair positions formally separated.

Daily and Dalton (1994) also revealed an association between the combination of CEO-duality, low proportions of independent directors and the likeliness of corporations to file Chapter 11 bankruptcy. The authors stated that “ . . . the bankrupt firms were found to rely more heavily on the dual leadership structure and fewer independent directors than their survivor counterparts” (Daily and Dalton, 1994:649). A recent study of Dahya et al. (1996) also found support for the assumption that corporate boards of directors are more effective when CEO and chair positions are not simultaneously occupied by one director. The study indicated that the separation of the responsibilities of chairman and CEO in a sample of 124 corporations was followed by significant and positive market reactions in the UK. This reaction was accompanied by enhanced performances of corporations according to accounting measures in the year following the change.

          

One-Tier Board Committees

Another attribute that receives much attention from boardroom reformers is the formation of board committees in one-tier boards. Harrison (1987) distinguishes two generic types of board committees. The first type is called the management support or operating committee. The primary function of these board committees is to integrate decision management with decision control in boards of directors. This is also reflected by the composition of operating committees. Most often, the composition of these board committees is dominated by executive directors. Examples of operating committees are the executive committee, the strategy committee and the finance committee.

As suggested by table 3.1, the second type of committee is concerned with the control roles of boards. These so-called monitoring or oversight committees aim at the protection of shareholders’ interests by providing objective, independent review of corporate decisions. The primary function of these committees is to separate decision management from decision control. Examples of oversight committees are the audit, compensation and nominating committees. Seen from a conflict perspective of board organization, oversight board committees can be effective mechanisms to separate decision management from decision control when these committees are composed primarily of non-executive directors who are independent of senior management (Verschoor, 1993).

 

Table 3.1

Generic Types of Board Committees

 

 

Attributes

 

Operating Committees

Monitoring Committees

Composition:

  • insider dominated.
  • outsider dominated.

Purpose:

  • advice to management.
  • accountability and legitimacy.

Function:

  • integration of decision management with decision control.
  • separation of decision management from decision control.

Examples:

  • executive committee;
  • finance committee;
  • strategy committee.
  • audit committee;
  • compensation committee;
  • nominating committee.

 

Source: based on Harrison (1987).

 

According to Davis (1991:77): “Management participation on these committees has been thought of as tantamount to allowing the ‘fox in the henhouse’.” Compared to other oversight committees, the audit committee has been studied most notably in the literature. As stated by Beasley (1994:33): “Audit committees can be viewed as monitoring mechanisms that are voluntarily employed in high agency cost situations to improve the quality of information flows between principal and agent.” Todd DeZoort (1997) sees audit committees as corporate governance mechanisms to protect the interests of shareholders by monitoring management and the external and internal auditors. Seen from another practical point of view, “ . . . definitions broadly agree that the audit committee is a board sub-committee of (predominantly) non-executive directors . . . concerned with audit, internal control and financial reporting matters” (Spira, 1998:30).

Comprised predominantly of independent non-executives, these and other oversight committees are accepted by reformers as valuable means to improve the independence of one-tier boards. As such, the following assumption suggests a positive association between independent oversight board committees and the independence of one-tier boards:

 

Based on a conflict perspective of board organization, assumption 1c suggests: independent oversight board committees of one-tier boards are positively associated with the separation of decision management from decision control.

 

Of importance to this study is the practical belief of boardroom reformers that oversight committees support the formal independence of one-tier boards. In line with agency theoretical assumptions, independent audit and compensation committees are required for corporations with a listing on the New York Stock Exchange and NASDAQ. Independent board committees are also recommended by the SEC and introduced through state legislation in the US. In England, a similar development can be observed in the formation of oversight board committees. According to Demb and Neubauer (1992b) one-tier boards tend to overcome the imbalance in the board by relying heavily on those committees. This imbalance derives from the unitary structure of one-tier boards. It can be therefore suggested that oversight board committees seem to act as additional structures in one-tier boards to facilitate a formal separation of decision management from decision control. Based on a conflict perspective of board organization, assumption 1d suggests:

 

Assumption 1d: the unitary structure of one-tier boards is negatively associated with the separation of decision management from decision control.

 

So far, very little work has been done in examining the effectiveness of oversight board committees as monitoring devices that support the formal independence of corporate boards and the financial performance of corporations (Cobb, 1993; McMullen, 1996; Todd DeZoort, 1997). Some authors have found support for the agency-theoretical assumption that audit committees composed of non-executives directors improve the independence of corporate boards and other measures that safeguard the interests of shareholders. Cobb (1993) found an association between the likelihood of court filings for fraudulent financial reporting and the existence of audit committees. Based on a sample of 96 corporations in the US, the study indicates that when the composition of audit committees does not adhere to the stringent definition of board independence (meaning that non of the members of the audit committee have ever had employment status with the corporation), the likelihood of fraudulent financial reporting increased. In a recent study, Beasley (1994) observed that “no-fraud firms” have more active audit committees than “fraud firms.”

The author found support for the assumption that audit committees may enhance “ . . . the board of director’s capacity to act as a management control by providing the board of directors with more detailed knowledge and complete understanding of financial statements and other financial information issued by the company” (Beasley, 1994:34). McMullen (1996) investigated the relationship between the presence of audit committees and the reliability of corporate financial reporting. The author selected 376 corporations that were confronted with shareholder litigation due to allegations of fraud, mistakes and errors in the financial statements of the corporations and with allegations of inadequate disclosure of financial information. The control sample in the study consisted of some 500 corporations.

In line with the assumptions of a conflict perspective of board organization, the results of the study indicated that the existence audit committees is associated with a lower number of shareholder lawsuits. Corporations with unreliable financial reporting were less likely to have audit committees than those not confronted with lawsuits. The study also suggested that the quality of financial statements improves when audit committees are established. In a similar vein, McMullen and Raghunandan (1996) found that corporations confronted with SEC enforcement actions and material restatements of quarterly earnings were much less likely to have audit committees consisting solely of non-executive directors than corporations that did not experience these enforcement actions.

 


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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.