2. The Role of Boards of Directors in Corporate Governance

Independent boards of directors are often seen as an essential element of a country’s corporate governance system. Fama (1980) sees the board as the ultimate internal monitor whose “ . . . most important role is to scrutinize the highest decision-makers within the firm.“ In an ideal corporate governance world, boards of directors provide oversight, monitor management and give credibility to a firm. They give advice to senior management and balance the interests of shareholders, employees and other stakeholders of the firm. As the shareholders’ agent, a director is ideally independent of management, well educated and highly skilled. A director preferably has a long standing track record in the company’s industry, understands financial terminology and is willing to defend shareholder value.

It takes dedication, highly specialized expertise, substantial financial resources, and a long term vision to change a country’s business culture and shareholder protection systems.

The nature of recent financial scandals has alerted law makers across the globe that directors and the governance systems in which they operate have not been sufficient to avoid the largest bankruptcies and destruction of shareholder value in history. In both the US and Europe, legislative programs have been recently introduced to improve the role and independence of boards of directors, the internal control systems of companies, the audit profession and companies’ disclosure requirements. Following the 2002 Sarbanes-Oxley Act in the US, a comprehensive EU Corporate Governance Program was launched in 2003 to restore trust in financial markets and the role of directors in protecting investors.

2.1    Directors’ Poor Image

Although recent high profile financial scandals may have severely undermined the trust in boards of directors in Western markets, trust levels among the public always have been low. A survey among 1,085 full time workers in 1998 indicates that only 11 percent of all workers in the UK strongly agreed with the following statement: “I trust and believe what the directors of my company say” (Mori, 1999). A similar survey in 2003 did not show much of an improvement: four in five people in Britain (80%) did not agree with the statement “Directors of large companies can be trusted to tell the truth.” In addition, 78 percent felt “directors of large companies are paid too much for the job they do” (Mori, 2003).

Illustration 1: Trust Among 22,000 People in Top-Managers.


Source: Wall Street Journal Europe (2003).

A survey by the Wall Street Journal Europe (2003) among some 22,000 people in 20 European countries and the United States revealed that 5 percent of the respondents had high trust in managers compared to 45 percent for doctors. The highest level of trust in top management came from Denmark (18%) and the lowest was from Germany (2%). Directors in emerging countries seem not to do much better.

A unique study among 1,000 shareholders in Macedonia found lower levels of trust in large companies (read management and directors) than in the country’s financial police (USAID, 2005).

2.2    Directors’ Remuneration

Bad publicity surrounding the remuneration of CEOs has also negatively affected the public’s trust in boards and their directors.
According to the AFLCIO (2002), the average CEO made 42 times the average blue-collar worker’s pay in 1980, 85 times in 1990 and 531 times in 2000 (in the US). In 2004, the average CEO of a major US company received $9.84 million in total compensation.[1]

In contrast, the average non-executive director of S&P 500 companies in the US received $50,000 for an average of 7 meetings (median) with the board and an average of 9.4 times in audit committees (Spencer Stuart, 2005a)[2].  In Europe, directors are facing similar reputation problems as both national legislators and the European Commission are requiring directors and their companies to be more transparent about their remuneration packages.[3]

2.3    Where are the Independent Directors?

The most experienced directors with established track records are beginning to leave the profession. Those that remain stay longer on boards and serve on fewer boards.

Due to changing legislation and interpretations of standards of good conduct, directors are required to meet ever higher standards to fulfill their duties of loyalty, care and good faith to avoid personal liabilities. New corporate governance standards are imposing greater responsibilities and liabilities on directors. Professional standards are increasingly complex and compliance requires significant investment in time and education.

Recruiters are faced with the impossible task of finding good candidates that meet independence requirements of multiple jurisdictions. According to Spencer Stuart, a large headhunter that specializes in executive search, “ . . . the recruiting task is more challenging and complex than ever, given a shrinking pool of traditional candidates, growing demand for specific director expertise and heightened sensitivity about director selection” (Spencer Stuart, 2005a).

. With shrinking pools of qualified candidates, directors who meet independence and professional capacity requirements are harder to find. The competition among corporations for qualified individuals is fierce (Griesedieck and Nahas, 2005).

2.4    Increasing Liabilities

A determining factor in the declining appetite of candidates to serve on boards of public companies is the increasing personal liability of directors. Although the business judgment rule has been providing protection to directors in some jurisdictions, an increasing number of cases such as Enron[4]  and WorldCom[5]  have forced non-executive directors to pay millions of dollars to settle claims by shareholders that are neither covered by Directors and Officers (D&O) insurance nor indemnified by their corporations.

A study found that 25% of directors who sat on almost 500 US-boards in 2001 turned down a new offer to serve on a board or resigned from previous board directorships in part due to liability concerns (McKinsey & Co, 2002). The same study asked directors to rate their colleagues on their performance as non-executive directors. The results of the study were revealing: almost half were rated as low or average performers and over a quarter were not considered to be truly independent (i.e., no ties to the company or management except through being a director).


[1] www.aflcio.org/corporatewatch/paywatch/pay

[2] In comparison, independent non-executive directors of the top 100 listed companies in the Netherlands received a retainer of € 38,000 in 2004 while stock options for non-executive directors are uncommon (Spencer Stuart, 2005b).

[3] See the European Commission’s recommendation on directors’ remuneration available on http://europa.eu.int/comm/internal_market

[4] “Ex-Directors at Enron to Chip in on Settlement” by Kurt Eichenwald in the New York Times of January 8, 2005: “Ten former directors of Enron agreed to pay $13 million as part of a $168 million settlement of a lawsuit brought by shareholders.”

[5] “Ten Ex-WorldCom Directors Agree to Settlement” by Brooke A. Masters and Kathleen Day in the Washington Post of January 6, 2005: “Ten former outside directors of WorldCom Inc. have tentatively agreed to pay $54 million, including $18 million out of their own pockets, to settle part of a class-action securities lawsuit stemming from the company's accounting scandal.”

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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.