by Lisa Mary Thompson
Corporate governance refers to the set of systems, principles and processes by which a company is governed. They provide the guidelines as to how the company can be directed or controlled such that it can fulfill its goals and objectives in a manner that adds to the value of the company and is also beneficial for all stakeholders in the long term. Stakeholders in this case would include everyone ranging from the board of directors, management, shareholders to customers, employees and society. The management of the company hence assumes the role of a trustee for all the others.
Professor Willian Ouchi explains Company Governance
Steve Jobs explains the rules of success
Richard M. Johnson: Importance of Independent Board of Directors for Family Businesses
Independent Board of Directors
by Steven Petra
Associate Professor at the Zarb School of Business, Hofstra University, Hempstead, NY, USA
Published by Emerald Group Publishing Limited
Purpose – Recent changes in corporate governance require firms to maintain boards with a majority of outside independent directors. The belief seems to be that outside independent directors will strengthen corporate boards by monitoring the actions of management and ensuring that management decisions are made in the best interests of the stockholders. This belief, however, may be founded on an assumption that has its roots in public perception and not in fact. The purpose of this paper is to determine whether or not outside independent directors strengthen corporate boards.
Design/methodology/approach – Five areas within corporate boards of directors, including board composition, CEO duality, audit committees, compensation committees and nominating committees, are examined. The results of studies aimed at discerning the effects that outside independent directors have on increased firm performance and shareholder wealth through strong corporate governance are discussed.
Findings – The conclusion reached is that outside independent directors do appear to strengthen corporate boards; however, more needs to be done to reestablish the market’s confidence in corporate America’s ability to effectively govern itself.
Practical implications – Best practices are discussed that can assist corporate boards in fulfilling their responsibilities to shareholders in monitoring and controlling the actions of management.
Originality/value – This paper is of value to management of firms, corporate directors, and investors. It demonstrates that the presence of outside independent directors alone will not solve the deficiencies exposed in corporate boardrooms. It also highlights the fact that more needs to be done to change the environment in which corporate boards operate in order to better protect shareholder interests.
No Social Ties: How Independent Boards Improve Firm Performance
Published: July 23, 2013 in Knowledge@Australian School of Business
When non-executive directors sit around a boardroom table making business decisions, they may be unaware that how they are selected and their degree of independence can have a significant impact on the returns their shareholders ultimately receive.
Research led by Ronald Masulis, a scientia professor of finance and Macquarie Group Chair in Financial Services at the Australian School of Business (ASB), helps clarify the complex link between board independence and company performance. It shows that independent boards are more likely to remove poorly performing CEOs from office, which leads to improved shareholder value.
There are, however, varying degrees of board independence. A second, important finding of the study is that the presence of a fully independent nominating committee, which reduces potential CEO influence on selection of directors, can create extra value beyond the benefits of having a board composed of a majority of directors who are technically independent.
The research has clear implications for Australian companies, particularly smaller companies outside the ASX 200, which tend to have less independent boards. It suggests that to maximise shareholder returns, you should increase your board’s actual independence and exclude the CEO and linked directors from the nominating committee. Furthermore, you shouldn’t wait until the regulators require you to do it.
“Forward-looking corporations that are trying to maximise shareholder wealth should be in front of regulators and should want to make the changes first,” says Masulis, who co-authored the study with Lixiong Guo, a senior lecturer at the ASB.
A Strong Causal Link
Other academic research has found inconsistent evidence of a positive correlation between independent directors and firm performance. But there is a more fundamental problem with this earlier evidence – correlation does not prove causation. Moreover, existing research has been unable to prove how board independence leads to increased value for shareholders.
Masulis observes that it is always difficult to prove causation. This is particularly true for the relationship between board structure and firm performance because boards are selected to meet certain stakeholder objectives which vary over time.
But when the US approved the Sarbanes-Oxley Act 2002 and US stock exchanges followed up with new listing requirements in response to the collapse of Enron and other scandals, Masulis and Guo saw a potential way of solving the causation conundrum. These regulatory changes, which imposed new independence requirements on boards and various board committees, including the nominating committee, allowed Masulis and Guo to sort US firms into two groups: (1) firms unaffected by the new rules because their board structure already satisfied the requirements; and (2) firms with board structures that did not satisfy the new rules. The researchers could then compare the performance of unaffected firms with the firms forced to make structural board changes to comply with the new regulations.
“This offered a unique opportunity to discover what happens to firm performance when board independence increases, because the structural change is due to regulatory compulsion, rather than a voluntary action by the firm,” Masulis says.
The research identifies a strong positive causal link between board independence and performance arising from board independence. With independent boards, CEOs face a greater risk of punishment (firing) for poor performance and this increases their incentives to perform well, which leads to better overall firm performance.
But what of the study’s second finding – that increasing the independence of the board’s nominating committee has a complementary effect beyond the benefits of having a majority of independent directors. Why would an independent nominating committee have such impact?
According to Masulis, outside directors like to be re-nominated. That means they are wary of being on the wrong side of the CEO. When the CEO is on the nominating committee, or has a friend or subordinate on it, the CEO has a means of retaliation against an independent director who is asking too many questions or being too critical. Such a director may not be re-nominated. A fully independent nominating committee protects against this danger.
Masulis says that while the research was based on US data and regulatory changes, it is possible to draw similar inferences for other common law countries, such as Australia, where corporation law has a comparable, though not identical, structure.
The research is particularly relevant to the ASX, which has voluntary corporate governance policies recommending that boards and nominating committees have a majority of independent directors. This is less stringent than the US position, where a majority of the board and all members of the audit, compensation and nominating committees are required by law to be independent.
The research, however, reinforces the merits of the ASX’s general policy in relation to board and nominating committee independence, by identifying tangible benefits to shareholders of such an approach. At the same time, these findings clearly point to how these policy guidelines can be improved.
Daniel Smith, head of Australian research at corporate governance adviser Institutional Shareholder Services, says that most of the boards in the ASX 200 have a majority of independent directors “which trickles through to nominating committees”.
But independence has different definitions. Masulis wants companies to lift the bar. He says that although many outside directors may be technically independent, the existence of strong social ties with the CEO and senior management can potentially subvert actual independence.
“These types of connections are less than ideal if these directors are really going to make decisions that are in the best interest of shareholders,” Masulis says. “Boards seeking to improve corporate governance should avoid appointing outside directors with strong social ties to senior management.”
Smith notes that there is also room for improvement in smaller companies outside the ASX 200. These companies tend to have smaller boards, often with six or less members. And many of these companies lack a designated nominating committee, relying instead on the entire board to perform this function.
So should the Australian government enact legislation requiring board or nominating committee independence? Smith doesn’t believe so. He considers the ASX corporate governance recommendations are a sufficient starting point.
Masulis is cautious about recommending legislation to require that nominating committees be fully independent, “at least until we have a better understanding of the trade-offs that are available from alternative definitions of independence and from different corporate governance adjustments”.
Instead, he believes that companies seeking to maximise shareholder value should be proactive in enhancing outside directors’ level of independence, including social ties, and in moving to a fully independent nominating committee.
“I would encourage corporate boards to voluntarily adopt a fully independent nominating committee, and if they are lacking a nominating committee, to establish one,” Masulis says. “It would also be worthwhile for the ASX to consider adding a recommendation in its code of best corporate governance practices to this effect.
Family businesses could suffer without appointing external boards, report finds
Family businesses are rife in Australia, but their future could be grim if they don’t appoint an external board for guidance, a new study shows.
New research into family business governance by Deloitte in the US found that 28% of family businesses do not have a board of directors at all.
Of the businesses with a board, the survey shows that for 42% of respondents, family members comprised at least 75% of the board. Only 39% of boards were controlled by a majority of non-family, non-executive members.
Deloitte Private chief operating officer in Australia, Michael Clarke, told SmartCompany this morning there are numerous parallels from the study to family businesses in Australia. Clarke says a lack of external guidance from a non-family board could be damaging to the future of the family businesses.
“This report is looking at how board oversight really can improve a business and be a strategic asset,” Clarke says.
“Whilst they (family businesses) are driven by their entrepreneurial flair, what they miss out on is that outsider’s perspective.”
Clarke says that family businesses are best placed if they have two layers of governance – the first at a family level that operates within the business, and an external board that reports to the family.
A key matter for the external board to address is the issue of succession planning, Clarke says. The research found 49% of the family businesses only review succession plans when a change in management requires it, and 41% do not have any leadership contingency plans in place.
“What the report said is that nearly half of the respondents only review succession plans when a change in management requires it. That is reactive, not proactive and that potentially leaves those businesses in a difficult situation if there is a succession issue. Or an issue with the management team.
He says that many businesses may have a longer-term succession plan, but have no idea who would take over the leadership if something were to happen unexpectedly in the short term. This topic can be emotional for families, he says, which is why an external perspective can assist.
“Sometimes having external parties on the board helps to bring in some of that governance and robustness to the debating process around these types of issues.”