Boards of Directors: Governance Issues

A board of directors is a group of individuals elected by the ownership of a corporation to have oversight and guidance over management and to look out for shareholders’ interests. The act of oversight and direction is referred to as governance. The National Association of Corporate Directors defines governance as “the characteristic of ensuring that long-term strategic objec­tives and plans are established and that the proper management structure is in place to achieve those objectives, while at the same time making sure that the structure functions to maintain the corporation’s integrity, reputation, and responsibility to its various constituencies.” Boards are held accountable for the entire performance of an organization. Boards of directors are increas­ingly sued by shareholders for mismanaging their interests. New accounting rules in the United States and Europe now enhance corporate-governance codes and require much more extensive financial disclosure among publicly held firms. The roles and duties of a board of directors can be divided into four broad categories, as indicated in Table 6-7.

Shareholders are increasingly wary of boards of directors. Most directors globally have ended their image as rubber-stamping friends of CEOs. Boards are more autonomous than ever and continually mindful of and responsive to legal and institutional-investor scrutiny. Boards are more cognizant of auditing and compliance issues and more reluctant to approve excessive compensation and perks. Boards stay much more abreast today of public scan­dals that attract shareholder and media attention. Increasingly, boards of directors monitor and review executive performance carefully without favoritism to executives, representing shareholders rather than the CEO. Boards are more proactive today, whereas in years past they were often merely reactive. These are all reasons why the chair of the board of direc­tors should not also serve as the firm’s CEO. In North America, the number of new incoming CEOs that also serve as Chair of the Board has declined to about 10 percent today from about 50 percent in 2001. Academic Research Capsule 6-2 reveals “how many” board of director members are ideal.

Until recently, individuals serving on boards of directors did most of their work sitting around polished mahogany tables. However, Hewlett-Packard’s directors, among many others, now log on to their own special board website twice a week and conduct business based on extensive confidential briefing information posted there by the firm’s top management team. Then the board members meet face-to-face fully informed every two months to discuss the big­gest issues facing the firm. New board involvement policies are aimed at curtailing lawsuits against board members.

How Many Board of Directors Members Are Ideal?

Recent research reveals that companies with fewer board mem­bers outperform larger boards, largely because having fewer di­rectors facilitates deeper debates, more nimble decision making, and greater accountability. For example, there are only 8 mem­bers on Apple’s board, and Apple is doing great. Recent research reveals that among companies with a market capitalization of at least $10 billion, smaller boards produced substantially higher shareholder returns between 2011 and 2014. Research also shows that 9-person boards perform much better, for example, than 14- to 15-member boards. As a result of this recent research, many companies are reducing their number of board members. Another benefit of fewer board members is that CEOs are more often rep­rimanded (or dismissed) if needed. Dr. David Yermack, a finance professor at New York University’s business school, reports that smaller boards are generally more decisive, more cohesive, more hands-on, and have more informal meetings and fewer commit­tees. Netflix is another example of a company with a small board, only 7 members, who debate extensively before approving impor­tant management moves. Netflix is doing great. In contrast, Eli Lilly & Co. has 14 board members who find it “too big to encour­age the kinds of discussions you want, because drilling down on different issues simply takes too long; members feel constrained even asking a second or third question.” Bank of America has 15 directors—too many to be efficient. In addition, the chair of the board should rarely, if ever, be the same person as the CEO, as dis­cussed. In summary, companies should seek to reduce their board of directors to fewer than 10 persons, whenever possible—and strategy students should examine this issue in their assigned case companies.

Source: Based on Joann Lublin, “Are Smaller Boards Better for Investors?” Wall Street Journal, August 27, 2014. Also based on Den Favaro, Per-Ola Karlsson, and Gary Neilson, “The $112 Billion CEO Succession Problem,” Strategy + Business, PwC Strategy (May 4, 2015).

Today, boards of directors are composed mostly of outsiders who are becoming more involved in organizations’ strategic management. The trend in the United States is toward much greater board member accountability with smaller boards, now averaging 12 members rather than 18 as they did a few years ago. BusinessWeek recently evaluated the boards of most large U.S. companies and provided the following “principles of good governance”:

1. Never have more than two of the firm’s executives (current or past) on the board.
2. Never allow a firm’s executives to serve on the board’s audit, compensation, or nominating committee.
3. Require all board members to own a large amount of the firm’s equity.
4. Require all board members to attend at least 75 percent of all meetings.
5. Require the board to meet annually to evaluate its own performance, without the CEO, COO, or top management in attendance.
6. Never allow the CEO to be chairperson of the board.
7. Never allow interlocking directorships (where a director or CEO sits on another director’s board).¹¹

Jeff Sonnerfeld, associate dean of the Yale School of Management, comments, “Boards of directors are now rolling up their sleeves and becoming much more closely involved with man­agement decision making.” Company CEOs and boards are required to personally certify finan­cial statements; company loans to company executives and directors are illegal; and there is faster reporting of insider stock transactions. Just as directors place more emphasis on staying informed about an organization’s health and operations, they are also taking a more active role in ensuring that publicly issued documents are accurate representations of a firm’s status. Failure to accept responsibility for auditing or evaluating a firm’s strategy is considered a serious breach of a direc­tor’s duties. Legal suits are becoming more common against directors for fraud, omissions, inac­curate disclosures, lack of due diligence, and culpable ignorance about a firm’s operations.

Source: David Fred, David Forest (2016), Strategic Management: A Competitive Advantage Approach, Concepts and Cases, Pearson (16th Edition).