4. Board of Directors Flashcards
LOs of the Board of Directors
- Explain executive and non-executive directors and their responsibilities.
- Understand the role of the board of directors.
- Explain why BoD exists using agency theory
- Explain why BoD exists using resource dependence theory,
Executive Directors and Non-Executive Directors: Executive Directors Characteristics
- CEOs, CFOs
- Elected by shareholders to the board.
- Concerned with day-to-day operations and involved in major strategic decisions.
- Provide board with information to facilitate NEDs role.
Executive Directors and Non-Executive Directors: Non-Executive Directors Characteristics
- Not contracted as employees, they are contracted to provide services.
- Board involved with finding suitable NED candidates, appointment approved by shareholder election.
- Have no role in day-to-day operations.
- Appoint and monitor senior executives.
- Scrutinise major strategic decisions M&A Divestment
Role of BoD: Overview of Roles
- Board at the apex of internal control system.
- Directors have a fiduciary duty to shareholders and the firm.
- Hire and fire senior executives.
- Monitor senior execs performance.
- Provide counsel on strategic decisions: corporate restructuring.
Theoretical Perspectives to do with BoD
- Agency Theory
- Resource Contingency Theory
Theoretical Perspectives: Agency Problem in BoD
- Separation of ownership and control.
- Execs employed to use skills, experience, and judgment on behalf of shareholders.
- Decisions are non-routine - require judgment.
- Incomplete contracts - makes it difficult to hold execs to account
- Disperse share ownership - shareholders do not monitor because costs > benefits.
Theoretical Perspectives: Agency Perspective
- The purpose of the board
- BoD monitors execs on shareholders behalf to reduce the agency problem.
- To promote value maximising behaviour by execs.
Theoretical Perspectives: Resource Dependency Theory
- BoD provide four types of resources
- Advice and counsel - human capital (skills, expertise, knowledge)
- Legitimacy - based on independence from senior execs.
- Channels of communication between firm and external organisations.
- Assistance in obtaining resources from outside the firm
- Last two points are networking.
Theoretical Perspectives: Resource Dependency Theory (Evidence)
- Lynell, Golden and Hillman 2003, AMR
Theoretical Perspectives: Summary
- NEDs are important in establishing the board as an effective governance device and as a resource to improve strategic decision-making.
- Effectiveness of board associated with NEDs independence and their human and social capital.
What are certain Board Characteristics?
- Outside directors
- Independence
- Size
- Diversity
- Female directors
LOs of Board Characteristics
- Explain how board characteristics impact on board effectiveness.
Board Characteristics: NEDs
- Appointed for expertise to monitor execs and advise on strategy,
- With no exec function, they can fulfil their duties independently.
- Do not rely on firm as their main source of income (in large FTSE PLCs they are paid about £78k)
- Play a crucial role in scrutinising execs because we cannot rely on execs to scrutinise themselves.
- Expect more NEDs on a board to lead to higher performance.
Board Characteristics: Board Independence
- NEDs need to be independent to fulfil their fiduciary duty to shareholders.
- Questionable if they are affiliated outsiders, boards are interlocked, entrenched or rely on execs for information.
- Lab market for NEDs disciplines those who have operated on boards whose firms have underperformed.
Board Characteristics: Size (Args for Larger Boards)
- More resources for monitoring and advice.
- More diverse expertise allowing members to specialise on committees.
- Complex firms benefit from larger board containing diverse expertise.
Board Characteristics: Size (Args Against Larger Board)
- Larger boards suffer from slower decision-making.
- Larger boards suffer from the ‘free-rider’ problem.
Board Characteristics: Diversity (Args for Diversity)
- Helps overcome groupthink, means decisions more likely to be challenged.
Board Characteristics: Diversity (Args Against)
- Might make it more difficult for decisions to be made due to less cohesiveness.
Board Characteristics: Female Directors
- Women under-represented on boards.
- Restrict pool of available talent on board if we do not use women.
- Quotas lead to accusations of tokenism.
Board Characteristics: Women on Boards in FTSE100 firms in 2021
- 431 (40.5%) of WD’s.
- 34 (16.5%) of WED’s
- 397 (46.4%) of WNED
- 9 (9%) of WCEO’s
- 19 (19%) WChairs
- 93 (93%) of firms with 33% of WDs
Board Characteristics: Ethnicity of FTSE100 Firms in 2021
- 178 (18%) of minority ethnic directorships.
- 63 (35%) of British ethnic minority directors.
- 96 (96%) of companies with one ethnic minority director.
- 7 (7%) of boards with ethnic minority CEO.
- 6 (6%) of board with ethnic minority board chair.
Board Characteristics: Summary
- Arguments link effectiveness of boards to board characteristics.
- More effective boards are (w respect to monitoring and counselling) are exp to be associated with better strategic decision-making and better firm performance.
Impact of BoD and Committee Characteristics
- CEO Exit
- Firm Performance
- M&A’s
Impact of BoD and Committee Characteristics: CEO Exit
- Expect outsiders (NEDs) to better monitor than insiders (Execs)
- No evidence of insiders/outsiders having an impact on CEOs exit when firm under-performs (Gregory-Smith et al 2009)
- CEOs with larger proportion of board appointed during their tenure are at significantly lower risk of dismissal (Gregory-Smith et al 2009)
Impact of BoD and Committee Characteristics: Firm Performance (Size)
- Dalton et al (1999) examined 131 studies and find evidence of a positive board size-performance relationship.
- For “simple” firms performance decreases in board size, but for “complex” firms performance increases in board size (Coles et. al 2008)
Impact of BoD and Committee Characteristics: Firm Performance (Outside Directors)
- Larger percentage of outside directors associated with higher performance (Pearce & Zahra, 1991)
Impact of BoD and Committee Characteristics: Firm Performance (Female Directors)
- Post and Byron 2015 examine 140 studies and find that female board representation is positively associated with accounting returns but has no impact on stock market performance.
Impact of BoD and Committee Characteristics: Ethnic Diversity Firm Performance
- No evidence of a relationship between ethnic diversity and performance.
Impact of BoD and Committee Characteristics: M&A’s (Outside Directors)
- Independent boards are more likely to resist takeover bids to get a higher price for shareholders (Cotter et al., 1997) (Glazers)
- Outside director’s prior experience of acquisitions in the same product market has a positive effect on post-acquisition performance (McDonald et al., 2008)
Impact of BoD and Committee Characteristics: M&A’s (Female Directors)
- Women less likely to suffer overconfidence than me.
- “Each additional female director is associated with 7.6% fewer bids, and each additional female director on a bidder board reduces the bid premium paid by 15.4% (Levi et., al 2014
Impact of BoD and Committee Characteristics: M&A (Ethnic Diversity)
- No relationship between ethnic diversity and post-acquisition performance (Guest 2019)
Impact of BoD and Committee Characteristics: Summary
- BoD is a key internal corporate governance device monitoring senior mgmt, setting exec pay, and assessing strategic decisions.
- Evidence suggests Board’s effectiveness varies with different characteristics but evidence not always clear.
