A recent presentation at my corporate governance colloquium raised the perrenial question of whether a corporation's board of director's function of monitoring management is merely primus inter pares or is the paramount function before which all other roles must give way.
In my article, Why a Board? Group Decisionmaking in Corporate Governance, I argued for the former understanding of the board:
What then does the board produce and how does it produce it? First, and foremost, the board monitors and disciplines top management. Second, while boards rarely are involved in day-to-day operational decision making, most boards have at least some managerial functions. Broad policymaking is commonly a board prerogative, for example. Even more commonly, however, individual board members provide advice and guidance to top managers with respect to operational and/or policy decisions. Finally, the board provides access to a network of contacts that may be useful in gathering resources and/or obtaining business. Outside directors affiliated with financial institutions, for example, apparently facilitate the firm’s access to capital.
This understanding of the board's role is critical to evaluating the debate over independent directors. Since Sarbanes-Oxley and the concurrent changes in the stock exchange listing standards, which I discussed in my article A Critique of the NYSE's Director Independence Listing Standards, most public corporations have been obliged to have a majority of board members who are independent of management. In addition, audit, nominating, and compensation committees staffed by outsiders are effectively required. One concern is that this trend will lead to more adversarial relations between boards and top managers. This concern is particularly pronounced when proposals are made to further incent independent directors to monitor management, as was recommended by our colloquium speaker, who encouraged greater SEC enforcement of rules designed to force independent directors to monitor corporate disclosures.
It is doubtful whether adversarial relations between the board and management help the former with their monitoring role (it may simply encourage management to treat outside directors like mushrooms). It seems clear, however, that encouraging an adversarial relationship between activist independent directors and outsiders is counter-productive.
In theory of course, independent board members could help the board fulfill all its roles. As to networking, for example, outside directors provide both their own expertise and interlocks with diverse contact networks. As to monitoring, at least according to conventional wisdom, board independence is an important device for constraining agency costs. A new paper from two European business scholars, however, suggest that board independence (at least insofar as it results in adversarial board-CEO relations) is undesirable because it intereferes with the board's non-monitoring functions:
Abstract: This paper analyzes the consequences of the board's dual role as an advisor as well as a monitor of management. As a result of this dual role, the CEO faces a trade-off in disclosing information to the board. On the one hand, if he reveals his information, he gets better advice. On the other hand, a more informed board will monitor him more intensively. Since an independent board is a tougher monitor, the CEO may be reluctant to share information with it. Thus, our model shows that management-friendly boards can be optimal.
My bottom line is that that one size does not fit all. Firms have unique needs and should be free to develop unique accountability mechanisms carefully tailored for the firm’s special needs. Unfortunately, regulators (and a lot of academics) keep trying to squeeze firms into that one size fits all suit.
