Governance Structures Flashcards
Chapter 2
GOVERNANCE THEORY RELATED TO BOARD STRUCTURE
The 3 different board theories will each guide different decision-making around what structure is most appropriate for a board to take.
What are the 3 different board theories and how they relate to board structure?
While it is important to have appropriate structures, what is the argument?
- Agency theory = executive management are inherently self-interested: theory regards the board as an instrument of control = board must strictly ensure its independence from management
- Stewardship theory = there is no conflict of interest between managers and owners and that, to be successful, an organisation needs a structure that allows co-ordination (e.g., fluid leadership boundary between NEDs and EDs = chair may also be CEO)
- Stakeholder theory = organisations have relationships with many groups that affect, or are affected by, its decisions = all stakeholder interests’ equal
Implications for board size (may be large due to stakeholder representation), diversity, tenure, remuneration, and other board tasks
they are not enough to ensure good governance, but must exist as the building blocks of strong and compliant board practice
DEFINING STRUCTURAL ELEMENTS OF BOARDS
Boards logically can fall into 1 of what 4 types?
The first 3 board configurations make up what?
- All-executive board e.g., start-up and family companies where the founder is the major shareholder as well as both the chair and CEO
- Majority executive board = mostly executives from the company’s top management positions plus some external NEDs
- Majority independent non-executive board = power balance is shifted to the external, with the aspiration of ensuring organisational accountability and compliance
(UK, US Australia) - 2-tier board = (1) external directors to govern, (2) internal personnel to manage
(Germany, Austria, Holland)
1-3 are unitary board structures
DEFINING STRUCTURAL ELEMENTS OF BOARDS - BASIC SET UP
What are the 3 basic-set considerations?
- RATIO OF EXECS/NEDs = ratio will depend upon organisational life cycle, sector type, country, company culture and various practical constraints
- BOARD SIZE = no minimum or maximum provisions that dictate board size, but will have an impact on the functioning of the board and will be affected by the particular requirements of the board and organisation
- COMMITEES STRUCTURE = standard are audit, remuneration and nomination = but size, meeting frequency and functioning of these committees may lead to a variety of other themed committees that may be useful to consider
DEFINING STRUCTURAL ELEMENTS OF BOARDS - CHAIR CONSIDERATIONS
What are the 3 chair considerations?
- CHAIR AND CEO SPLIT ROLE = the most defining structural feature indicating whether the board set-up is attempting to ensure external independence (a chair/CEO split) or management leadership (chair and chief executive officer are the same person)
- CHAIR AS FORMER CEO = perhaps not as overtly conflicting as a joint role, this succession is also subject to compliance and is assumed to reduce independence and therefore have an impact on governance
- CHAIR IS EITHER EXECUTIVE OR NON-EXECUTIVE = an executive chair is assumed to reduce the level of independence of the chair’s role
DEFINING STRUCTURAL ELEMENTS OF BOARDS - DIRECTOR CONSIDERATIONS
What are the 3 director considerations?
- AVERAGE TENURE = assumption here is that directors will become less independent and perhaps more conflicted over time
- BOARD DIVERSITY = a board may need to comply with certain codes or sector expectations to ensure there are, for example, appropriate levels of gender and ethnic diversity on the board.
Beyond this, boards may also be interested in reflecting their stakeholder diversity within the boardroom’s membership - DIRECTOR COMPENSATION = to what extent they are remunerated for their work on the board/committees/chairing, whether they are part of any incentive scheme and what percentage of equity they hold
DEFINING STRUCTURAL ELEMENTS OF BOARDS - BOARD TASKS
What are the 3 board task considerations?
- BOARD MEETING FREQUENCEY = how frequently they meet will depend upon practicalities relating to the size and location of board membership, current business requirements, and external environmental factors
- BOARD REVIEW/EVALUATION = FTSE 350 boards are required to review themselves every year and be reviewed externally at least once every three years
- BOARD INDUCTION AND DEVELOPMENT = Ideally, every director will commence their board directorship with an appropriate induction and will continue to be developed in the role throughout their tenure
IMPACT OF BOARD STRUCTURES ON PERFORMANCE - BASIC SET-UP - RATIO OF EDs TO NEDs
What does Principle G of the 2018 UK CG Code say?
What does Provision 11 of the 2018 UK CG Code say?
Why is the evidence from research and practice contradictory on the best ratios and greater or lesser contributions of independent and non-executive directors?
Therefore, moving beyond the formal definition of independence as ‘free from conflicts of interest’ to what, may what?
Principle G = The board should include an appropriate combination of executive and non-executive directors, such that no one individual or small group of individuals dominates the board’s decision-making
Provision 11 = At least half the board, excluding the chair, should be non-executive directors whom the board considers to be independent
Because there will be times when outsider-dominated boards may be better (e.g., during the strategic decision-making process) and also times when insider-dominated boards are more positive too (e.g., driving entrepreneurial activities of the company)
To ‘having the right attitude’ may helpfully shift the focus from the structural to the more psychological and perhaps from a compliance mindset to one more akin to stewardship
IMPACT OF BOARD STRUCTURES ON PERFORMANCE - BASIC SET-UP - BOARD SIZE
The UK CG Code does not prescribe any particular board size, but does suggest what?
What is the average size of FTSE top 150 company boards?
For a board to determine its most appropriate size of membership, what 5 things should be considered?
The board should be of sufficient size that the requirements of the business can be met and … should not be so large as to be unwieldy
10.1
(1) the current size of the company
(2) the type of industry or sector the company operates in
(3) the current ‘life stage’ of the organisation
(4) the focus and requirements of current organisational strategy
(5) the time, skill and knowledge requirements of the various board committees
IMPACT OF BOARD STRUCTURES ON PERFORMANCE - BASIC SET-UP - BOARD SIZE
How can board size affect board effectiveness? (3)
When looking at effective board size, what conclusion can be drawn from Bob Sutton’s research?
What can be one of the problems with a larger board?
May affect:
(1) the skill of the chair in managing effective, efficient and inclusive dialogue of a larger group of directors
(2) the time, commitment and ability the chair has to develop relationships with directors outside of the boardroom
(3) the practicality of managing and securing consistent attendance of often very busy senior individuals
performance problems and interpersonal friction can exponentially increase once membership rises over 9
each director must divide their attention among a wider number of people = the board’s interpersonal trust and social glue will decrease = consequentially heightening the opportunity for destructive conflict
IMPACT OF BOARD STRUCTURES ON PERFORMANCE - BASIC SET-UP - BOARD COMMITTEE STRUCTURE
Certain board committee structures are a requirement to create and to disclose in board reporting. What are the main 3 committees?
In certain sectors, certain committees may be necessary. Name an example.
What are committees often created for?
How many meetings may a committee undertake each year?
There is little conclusive evidence that committees have beneficial impact on company performance. Therefore, board committee structures and meeting frequencies should be based on what?
Audit, nomination, and remuneration
E.g., finance sector organisations will often choose to create a risk committee
Created for whatever the current strategic need of the organisation may be
Varies and will depend on a variety of factors pertaining to the function of each particular committee
Should be based on works best for each individual board
IMPACT OF BOARD STRUCTURES ON PERFORMANCE - CHAIR CONSIDERATIONS - CHAIR AND CEO SPLIT ROLE
What does the 2018 UK CG Code say on a dual role of CEO and Chair? (1 Principle and 2 Provisions)
What is this based on?
Therefore, what is required?
What is the benefit of an independent chair?
Principle G = There should be a clear division of responsibilities between the leadership of the board and the executive leadership of the company’s business
Provision 9 = The roles of chair and chief executive should not be exercised by the same individual
Provision 14 = The responsibilities of the chair, chief executive, senior independent director, board and committees should be clear, set out in writing, agreed by the board and made publicly available
based on the agency theory proposal that company management may follow their own interests, rather than the ownership’s interest
an independent monitoring function is required to protect shareholders’ interests = split CEO and chair allows this
Benefit = an independent chair may focus more on ensuring open debate than simply accomplishing an agenda, and running the board rather than running the company
IMPACT OF BOARD STRUCTURES ON PERFORMANCE - CHAIR CONSIDERATIONS - CHAIR AND CEO SPLIT ROLE
In the US, many organisations have one person who is chair and CEO. What does this approach align with?
What are the 4 potential benefits of a dual role?
What does research tend to suggest regarding the relationship between duality and performance?
aligns more with a stakeholder theory perspective
Potential benefits of dual role:
(1) stakeholder theory argues that the superiority of the amount and quality of information may lead to better evaluation of top managers
(2) no confusion about who is leading the company and who has accountability
(3) may enable more things to be done at pace
(4) there may be times, such as during a chief executive transition or a period of organisational crisis, where individual strong leadership may be warranted
suggest that the relationship between duality and performance is mostly contingent on organisational characteristics and the business environment = many recent high-profile failures show that duality does not guarantee effective board governance
IMPACT OF BOARD STRUCTURES ON PERFORMANCE - CHAIR CONSIDERATIONS - CHAIR NOT FORMER CEO & CHAIR AS AN EXECUTIVE VS NON-EXECUTIVE
What does the 2018 UK CG Code say on independent chairs?
Name an example in the UK when the chief executive has gone on to become chair without any significant protest from shareholders or investors.
Provision 9 = The chair should be independent on appointment. … A chief executive should not become chair of the same company. If, exceptionally, this is proposed by the board, major shareholders should be consulted ahead of appointment. The board should set out its reasons to all shareholders at the time of the appointment and also publish these on the company website.
in 2005, the Group Chief Executive of HSBC became the Chairman and then Group Executive Chairman in June 2006
IMPACT OF BOARD STRUCTURES ON PERFORMANCE - DIRECTOR CONSIDERATIONS - TENURE
Director tenure will fluctuate significantly depending on what? (3)
What is the average length of service of FTSE 150 directors?
What does the 2018 UK CG Code say on the chair’s and non-executive directors’ tenure? (2)
To facilitate effective succession planning and the development of a diverse board, the tenure of the chair may what?
What does the research show in relation to tenure and performance?
What may the benefit be of longer tenure?
(1) country, (2) sector, (3) industry type
4.3 years
(1) Provision 19 = the chair should not remain in post beyond 9 years from the date of their first appointment to the board
(2) Provision 10 = serving on the board for 9+ years is likely to impair independence
be extended for a limited time, particularly where the chair was an existing NED on appointment (prov 19)
Some research found no link to length of tenure and performance
longer service equates with increased age, which has been correlated with increased wisdom and job-related decision-making
IMPACT OF BOARD STRUCTURES ON PERFORMANCE - DIRECTOR CONSIDERATIONS - DIVERSITY
There is no one tick-box diversity configuration of a board that confers better board performance and governance.
However, from a board structure perspective, the 2 main arguments for diversity are what?
Out of the FTSE 150 boards, what are the diversity statistics? (4)
What are the 3 positive outcomes that gender diversity on boards brings?
(A) ethical inclusion (gender and ethnic minority diversity) and (B) stakeholder voice (helps improve board decision-making)
(1) female directors account for 34% of directorships
(2) 51% of FTSE 150 Boards have a BAME director
(3) number of ‘foreign directors’ on FTSE 150 Boards is 30%
(4) average age of FTSE 150 non-executives is 59.3 years
(1) firms with more gender diversity on boards hold more board meetings
(2) firms with more volatility in their stock returns have fewer women on their boards
(3) firms with more gender diversity on their boards give their directors more pay-for-performance incentives
