Welcome to Class 5
Corporate Boards of Directors
Chapter 4
Early in the last century the majority of large corporations were
owned and controlled by a small number of capitalists.
Over time the stockholdings were dispersed to many
beneficiaries.
Beneficiaries were generally uninvolved in the firms so they
passed control of operational decision-making to insiders with
specialized expertise (management.)
This meant a separation of management from ownership.
The separation gave rise to two different theories of implications:
1. Agency Theory
2. Stewardship Theory
Agency Theorists believe:
1) TMTs need to be watched carefully since the separation
of management and ownership will can easily lead to
fiduciary lapses caused by conflicts of interest.
2) TMTs are susceptible to self-serving decisions that
disadvantage shareholders.
3) No one understands how to manipulate the firm to their
advantage more effectively than the TMT.
4) Independent board oversight is crucial to discouraging
TMTs from self-serving decisions.
5) Duality is believed to accentuate the opportunity for
fiduciary lapses that disadvantage the shareholders.
Shareholders depend on directors to prevent fiduciary
lapses.
Corporate boards are an important part of governance.
Boards have legal authority to dismiss poorly
performing TMTs.
Boards should be closely involved in major corporate
decisions.
Many boards ARE NOT fulfilling their responsibilities.
In the 1980s, frustrated by board refusal to
challenge management decisions, investors
began to DEMAND CHANGES.
1. Boards were expected to be more proactive in
their oversight role.
2. Boards were expected to END duality in
which the Board Chair is also the CEO.
Many investors believe the worldwide financial
meltdown of 2009 was a confirmation of useless
corporate boards.
Governmental agencies from around the world
began issuing a stream of new regulations
related to corporate boards.
But
Not everyone is critical of Boards & TMTs!
Stewardship Theorists believe:
1) TMTs can be trusted
2) They are capable and honest stewards of a firm’s
resources.
3) No one understands or cares about the corporation
more than those who actually manage it.
4) They DO NOT need independent board oversight.
5) Duality is believed to make a positive contribution to
corporate governance.
There are fewer
Stewardship Theorists
than there are
Agency Theorists.
Studies of Corporate Boards reveal:
Not all boards perform in the same way.
Some Boards fulfill their fiduciary responsibility
and others do not.
Transformational Motivators can alter the quality of
Board performance:
Primary Transformational Motivators are:
1. Board Environment
2. Board Re-Configuration
Board
Environment
Transformational
Motivators
Board
Reconfiguration
a. Peer Pressure by other board members to conform to
a new norms.
b. Lawsuits by shareholders or creditors are likely to
motivate directors to become more concerned about
TMT decisions and actions.
c. Dismal firm performance is likely to unnerve
directors and encourage boards to get more deeply
involved in decision-making.
d. Government regulations – new laws or more
rigorous enforcement of existing laws is a strong
motivator for changes in board behavior.
e.g. Sarbanes-Oxley Act of 2002 (SOX)
Peer
Pressure
Board
Regulation
Environment
Dismal
Performance
Lawsuits
Research has shown:
a. Women – Women on corporate boards “positively”
influences organizational citizenship.
b. Professional expertise – Configuration of professional
expertise on boards influences performance. Bankers and
others with financial experience on corporate boards have
been associated with stabilizing stock returns.
c. Average age – Younger boards tend to outperform older
boards.
d. Committee membership changes – When powerful
committees such as executive compensation committees
change, board power can shift from insiders to outsiders or
vice versa. This could tame run-away executive
compensation packages.
e. Inside/outside director ratio: Increasing outside board
members intensifies challenges to CEO decisions.
f. Board Size – As boards become larger they tend to display
dysfunctional characteristics.
g. CEO Tenure – As the tenure of the Chief Executive Officer
increases, so does the influence over the boards.
h. Duality – Occurs when the CEO is also (COB).
With duality board independence is diminished.
i. Board interlocks occur when two or more corporate boards
have common members (common control*).
* Common control = two different firms influenced (controlled) by same individuals
Some board interlocks are okay and others are illegal!
Women
Duality
Expertise
CEO
Tenure
Age
Board
Reconfiguration
Committee
Changes
Size
Interlocks
In/out
Ratio
Interlocking directorates of competing firms are subject to
prohibition and regulation under the Clayton Antitrust
Act. 15 U.S.C. §19 enacted in 1914.
The antitrust rule against interlocking directorates was
designed to prevent anti-competitive coordination between
organizations.
However, the Federal Trade Commission (FTC) seldom
pursues violations unless a complaint is filed.
Concerns of Interlocking Boards:
1. Potential for unfair, self-serving exchange of nonpublic information.
2. Sitting on too many boards = too little time for
exercising due diligence in protecting the interests
of shareholders.
3. Risk of addiction to the perks of multiple corporate
boards – directors may measure their achievements
by the number of boards they are on rather than by
what they actually contribute.
Interlocks are a common practice in the United States –
a perpetual concern of the federal government.
The U.S. Government has attempted to manage some
of the more troubling aspects with antitrust laws.
For example, as far back as 1890, the U.S. Government
passed the Sherman Antitrust Act.
However, none of these Acts make it illegal to sit on
multiple boards of non-competing companies and
this practice of interlocking boards continues.
Benefits of Interlocking Boards
These Directors may:
1. Offer unique knowledge of a particular commercial market.
2. Be uniquely qualified to interpret the conditions and
environment surrounding diversification targets.
3. Be able to provide objective expertise about potential
strategies and tactics for diversification process.
SOX provides teeth for civil and criminal
enforcement over the conduct of corporate boards.
SOX:
Contains substantial penalties associated with boards that
fail to exercise due diligence.
Makes it easier to prosecute securities fraud, particularly
financial fraud.
Reasserts board independence from corporate
management.
Places greater responsibility on senior management and
directors, particularly independent directors.
Demands that Independent directors on the audit
committee are to be more diligent in:
1. Overseeing and monitoring the financial reporting process
2. Establishing internal controls
3. Assuring performance transparency
All corporate boards can be divided into two basic
categories:
(1) those that do something (proactive) and;
(2) those that do nothing (sedate).
Proactive boards
Question the actions and decision of management
and are not afraid to insist that changes be made.
Sedate boards
Are frequently head bobbers, nodding in agreement
with all proposals. They do not want to “rock-theboat.”
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1. Number of directors
2. Number of insiders on the board
3. Number of women on the board
4. Number of educators on the board
5. Number of outside directors with
accounting/finance experience on the board
6. Whether or not the company practices duality (CEO is
also COB)
7. Average age of board members
8. Oldest board member
9. Youngest board member
10. Average tenure of board member
11. Shortest tenure
12. Longest tenure
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(Class 7) you meet with your individual teams.
There will be no formal class meeting in the
classroom but you are required to attend your
team meeting.
Attendance will be taken by the team secretary.
Merger Activity: Review carefully the following
site:

http://www.albany.edu/faculty/vanness/481NEW/merg
erind.pdf
Directors?