The analyses in chapter five of this study indicate that the importance of corporate governance is not only recognized in the national debates in the US and the UK. The diffusion of self-regulation in corporate governance also has become visible in continental European countries and other financial markets. This study found pressures from the following sources:
- the introduction of codes of best practices and guidelines;
- the modification of listing rules of stock exchanges;
- the globalization and unification of equity markets;
- the harmonization of corporation laws;
- the role of institutional investors in corporate governance.
In general, stock exchanges are putting more weight on new governance standards by means of voluntary codes of best practices and by making amendments to their listing rules. The European equity market is showing the first signs of unification which may result to the harmonization of corporate governance standards in Europe. Governance standards of exchanges in the US and the UK also seem to influence listing requirements of exchanges in other financial regions such as Asia, the Pacific and Eastern Europe.
The harmonization of corporation laws has been exemplified by the development in the EU where the Draft Fifth Directive on Company Law may result to the unification of corporation laws that set forth new governance standards in Europe. In addition, institutional investors have become more active in the field of corporate governance. CalPERS, HERMES and others are not only establishing standard principles in their regional market places. Institutional investors also play a role in the development of new global corporate governance principles and standards.
The relationship between these pressures and the transformation and convergence of corporate boards of directors is illustrated in figure 9.2. This figure suggests that external pressures lead to changes in the way directors organize their boards of directors. These changes may have both implications for practitioners, exchanges, investors as well as for academics involved in theory building. These implications are presented in the following sections of this paragraph.
Research Findings Summarized
Sources: chapter 5 and part II of this study.
Implications for Directors
As previously observed in this study, developments in corporate governance indicate that directors are increasingly adhering to new corporate governance standards. Emerging standards pressure directors to recognize that corporate governance is not only a matter of interest to institutional investors, stock exchanges and regulators. Listed corporations and their directors are also asked to understand the importance for corporations to comply with new corporate governance standards (see also figure 9.3).
As such, changes can be observed in the formal organization of boards of directors in listed corporations in the US, the UK and the Netherlands. The globalization of governance standards, the internationalization of corporations and the harmonization of equity markets are also stimulating directors to understand the subtle differences in boardroom cultures, working methods and board organization in different financial regions. The increasing importance of self-regulation in corporate governance is also confronting directors with the responsibility to voluntarily comply with new standards. Directors are also increasingly confronted with the need to generate more openness, disclosure and transparency on their working methods.
Figure 9.3 Implications for Corporate Boards of Directors
Implications for Stock Exchanges and Other Regulators
Seen from a practical point of view, the transformation and convergence of corporate boards may also have implications for public regulators and self-regulatory bodies such as stock exchanges and professional associations. Related to this study, international developments in corporate governance increasingly force exchanges to set forth new corporate governance standards while they fight for a piece of the financial pie (Griffith, 1990). As indicated in chapter five of this study, self-regulation is essential to the initiatives of stock exchanges that aim at the amendment of listing rules and the adoption of codes of best practices. Most exchanges refer to codes of best practices and rely on the professional discipline of directors to comply with new or changing corporate governance standards. In addition, the analyses in chapters six and seven of this study indicate that the governance systems in the US and the UK rely heavily on the disclosure of board practices and not on regulation through litigation.
Figure 9.4 Implications for Stock Exchanges and Other Regulators
Although corporation laws seem to dictate the governance structure in more detail in the Netherlands, the Peters Committee’s forty recommendations also strongly build on self-regulation. So, what does the transformation and convergence of board models mean for exchanges and other regulators that mainly rely on self-regulation in corporate governance? First, the transformation and convergence of board models may suggest that self-regulation is a mechanism that can effectively change and/or regulate the governance structure of listed corporations when exchanges have the power and the will to penalize “offenders” of the code. Second, changes in the governance structure of corporations may suggest that directors understand the need to comply with international standards to attract investments and to build investor confidence. In addition, it may suggest that directors do understand the potential benefits of self-regulation such as the flexibility of corporations to implement guidelines and to adapt governance structures that meet specific demands and needs not foreseen by statutory regulation.
Although Whittington (1993) indicates that self-regulation can be associated with a potential enforcement problem when new standards conflict with the interests of parties involved, the first compliance reports indicate that self-regulation, in conjunction with other pressures, positively contributes to the introduction of international corporate governance standards. Moreover, the transformation and convergence of corporate boards of directors may contribute to the confidence regulators may have in the effectiveness of self-regulation in the field of corporate governance (Cadbury, 1995; Samuels et al., 1996; Conyon and Mallin, 1997; Peasnell et al., 1998).
Implications for Institutional Investors
What does the transformation and convergence of board models mean for institutional investors? First, it may suggest that directors are increasingly responding to pressures from institutional investors to change the governance structure of their boards. Del Guercio and Hawkins (1997) found that institutional investors have been successful in promoting corporate changes in listed corporations. McCarthy (1996) also states that it is hard to ignore the pressures from institutional investors on corporate governance practices of listed corporations in Anglo-Saxon countries. Shareholder proposals from CalPERS and other institutional investors have indeed been followed with changes in the governance structure of listed corporations such as General Motors and other high profile corporations in the US. Yet, corporate governance standards vary between institutional investors. The Russell Reynolds Associates’ 1998 International Survey of Institutional Investors found that institutional investors strongly favor the separation of CEO and chair roles in the UK. A total of 85 percent of surveyed institutional investors are in favor of such an independent leadership structure. In the US, only 45 percent prefers an independent board leadership structure. In addition to other pressures, these findings are in line with the changes directors have made in the governance structure of their boards in the two countries.
Second, are shareholder proposals that aim at the modification of the composition and structure of boards also effective? In other words, do changes in the governance structure of corporations also result in improvements of the performance of corporations? CalPERS claims that an investment of USD 500,000 in shareholder activism leads to additional earnings of tens of millions of US-dollars (Pomeranz, 1998). As indicated by the literature review in chapters three and four of this study, the relationship between governance structures and financial performance is still a controversial one. The inconclusive findings in the literature suggest support for a consensus perspective of board organization that board structures with dual board leadership structures and insider-dominated boards are not necessarily dysfunctional.
In summary, research fails to prove conclusive findings that support a negative relationship between insider-dominated board composition and performance criteria as suggested by a conflict perspective of board organization. In response to these findings, Bhagat and Black (1997:45) propose that .” . . the burden of proof should perhaps shift to those who support the conventional wisdom that a monitoring board – composed predominantly of independent directors – is an important element of improved corporate governance.” Seen from a more practical point of view, Donaldson and Davis (1994) state: ”We believe that it would be unwise at the present time to go along with calls to require boards of corporations to be dominated by non-executives.”
Related to the leadership structure of boards, Baliga et al. (1996:51) report: “Our findings stand in sharp contrast to the recommendations of those who call for the abolition of duality as a primary way to improve firm governance and performance. The finding of no significant difference in the operating performance suggest that a duality status change . . . is more a variant of the ‘scapegoating phenomenon’ . . . and a symbolic way of ‘signaling’ that the board is effectively exercising its governance role . . . than an effective way of motivating fundamental change in firm performance.” And, related to the composition of board committees, Daily et al. (1988) indicate that they found no evidence of a systematic relationship between the composition of compensation committees and levels of CEO compensation. According to the authors, “these results are particularly intriguing given the emphasis both academics and the institutional investment community are placing on director independence” (Daily et al., 1988:215).
As such, these results not only have policy implications for institutional investors. Also exchanges and other regulators are confronted with “ . . . the fundamental disagreement between those advocating reform (corporate reformers) and defenders of the status quo (corporate federalists) about the efficacy of market forces in assuring managerial accountability to shareholders” (Malec, 1995:86).
Figure 9.5 Implications for Institutional Investors
Although it is too early to indicate that shareholder activism has a positive impact on the formal independence of corporate boards in the US, Europe and other financial regions, the first initiatives may indicate the start of an inevitable process in which listed corporations increasingly are confronted with pressures from institutional investors to transform their board structures into more independent models.
In addition to the practical implications for directors, regulators and institutional investors, the research findings of this study may also have implications for academics and others involved in theory building. First, the review of corporate governance literature shows that competing theoretical perspectives of corporate governance provide contrasting design strategies of board organization. As suggested above, the inconclusive research findings in the literature indicate that there is no clear relationship between the effectiveness of design strategies related to the governance structure of boards of directors and the financial performance of corporations.
Figure 9.6 Theoretical Implications
Although leading researchers in corporate governance claim that independent structures are superior to dual structures, the first theoretical implication of the research findings of this study seems to be that there is no one best way to organize corporate boards. Demb and Neubauer (1990:156) state: “There is no perfect structure for a board. Each company must put a board in place with a composition and shape – tailored to fit its legal environment, the company’s size and development stage, and the personality of its Chairman and CEO.” This means that the applicability of the compelling perspectives of board organization seems to depend on situational factors (Davis et al., 1997; Muth and Donaldson; 1998).
According to Donaldson (1990:377), the stewardship theory and the agency theory may be valid within their own domains: “For instance, stewardship theory may prove correct as long as the coalition . . . between managers and owners persists and is perceived by managers as persisting. Under conditions where the existing coalition between managers and owners is called into question, such as by a takeover threat, the interests of each party start to diverge; this is when agency theory may prove correct.” Or, as stated by Boyd (1995), both theoretical perspectives are correct under different circumstances. A challenge for future research is to determine these contingent factors.
This means that both perspectives are not necessarily non-complementary when researchers try to understand the complex relationship between the formal organization of corporate boards and the involvement of directors in decision management and decision control. Second, the emphasis in the literature on the formal independence of corporate boards suggests that some scholars underestimate the importance of informal mechanisms that support directors’ involvement in decision making.
This study demonstrates that supervisory directors can by-pass the formal structure with informal arrangements in the Netherlands. It is a common practice of the supervisory board to organize joint meetings with the entire management board. Supervisory directors have also voluntarily formed board committees composed of managing directors and supervisory directors. Sometimes, formerly affiliated directors are appointed to supervisory boards. These observations challenge the widespread agency theoretical belief that formal structures with independent board leadership and separate management and supervisory boards by definition create independent boards.
In practice, this may indicate that boardroom reformers who strongly focus on the alteration of formal board structures, should also consider the limitations of formal board structures that are supposed to support the formal independence of corporate boards.
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