Active Boards of Directors in Foreign Subsidiaries

• DOI: http://doi.org/10.1111/j.1467-8683.2010.00844.x
• Author: Yan Du,Ann Jorissen,Marc Deloof
• Published date: 01 March 2011
• Date: 01 March 2011

Active Boards of Directors in

Foreign Subsidiariescorg_844153..168

Yan Du*, Marc Deloof, and Ann Jorissen

ABSTRACT

Manuscript Type: Empirical

Research Question/Issue: This study examines the conditions under which foreign subsidiaries maintain active boards of

directors. Active boards are in this study def‌ined as boards that perform tasks beyond fulf‌illing local legal requirements. We

focus on both monitoring and service roles.

Research Findings/Insights: Based on a sample of 83 foreign subsidiaries operating in Belgium with headquarters in 14

different countries, we f‌ind that a foreign subsidiary is more likely to maintain an active board if it is a world mandate

subsidiary, which has worldwide responsibility for a product line and performs a broad scope of value-added activities.

Moreover, a foreign subsidiary is more likelyto maintain an active board if it is larger relative to the multinational enterprise

(MNE), if it has a higher level of local responsiveness, and if its past performance is poorer. Additionally, the presence of an

active board in a foreign subsidiary is related to other control mechanisms deployed in the subsidiary.

Theoretical/Academic Implications: Our results highlight the conditions under which foreign subsidiaries are likely to

maintain active boards. Moreover, we provide empirical evidence that agency theory and resource dependence theory are

relevant and complementary in the analysis of active boards in foreign subsidiaries.

Practitioner/Policy Implications: This study suggests that an active board may be a control mechanism to govern foreign

subsidiaries and an instrument to deal with the external environment. Corporate governance regulators may consider

developing governance recommendations that emphasize the importance of subsidiary boards in the oversight of foreign

subsidiaries.

Keywords: Corporate Governance, Subsidiary Governance, Board of Directors, Multinational Enterprise

INTRODUCTION

In many countries, corporate law requires foreign subsid-

iaries to haveboards of directors.1Given the importance of

foreign subsidiaries in the operation of multinational enter-

prises (MNEs) and the complexities of managing geographi-

cally dispersed and culturally distant foreign subsidiaries,

one would expect that MNEs use subsidiary boards strategi-

cally to govern foreign subsidiaries. However, in practice

some subsidiary boards are only rubber stamps set up to

fulf‌ill local legal requirements (Björkman, 1994; Gillies &

Dickinson, 1999). Thisraises the question of when subsidiary

boards play an active role in the governance of foreign

subsidiaries.

This study addresses this issue by empirically investigat-

ing the conditions under which foreign subsidiaries

maintain active boards. Active boards in this study are

def‌ined as boards that perform tasks beyond fulf‌illing local

legal requirements. We focus on both monitoring and

service roles. The corporate governance literature has inves-

tigated the composition and structure of boards in stand

alone f‌irms (e.g., Adams, Hermalin, & Weisbach, 2010; Her-

malin & Weisbach, 2003; Johnson, Daily, & Ellstrand, 1996;

Pugliese, Bezemer, Zattoni, Huse, Van Den Bosch, & Vol-

berda, 2009; Van Ees, Gabrielsson, & Huse, 2009; Zahra &

Pearce, 1989) and codes of good governance in a given

country (e.g., Aguilera & Cuervo-Cazurra, 2004, 2009;

Cromme, 2005; Zattoni & Cuomo, 2008). However, very

little research attention has been paid to subsidiary boards.

As far as we know, none of the few empirical studies on

subsidiary boards has addressed the conditions under

which foreign subsidiaries maintain active boards.

The international business literature has investigated

various control mechanisms used in MNEs, such as incen-

tive compensation, subsidiary staff‌ing, and corporate social-

ization (e.g., Ambos & Schlegelmilch, 2007; Baliga &

*Address for correspondence: Department of Accounting and Finance, University of

Antwerp, Prinsstraat13, 2000 Antwerp, Belgium. Tel: +32-3-265-40-73; Fax: +32-3-265-

40-64; E-mail: yan.du@ua.ac.be

153

Corporate Governance: An International Review, 2011, 19(2): 153–168

© 2011 Blackwell Publishing Ltd

doi:10.1111/j.1467-8683.2010.00844.x

Jaeger, 1984; Chung, Gibbons, & Schoch, 2000; Gencturk &

Aulakh, 1995; Ghoshal & Nohria, 1989; Gong, 2003; Jaussaud

& Schaaper, 2006; O’Donnell, 2000; Roth & O’Donnell, 1996).

However, less is known with respect to the role of the sub-

sidiary board as an alternative control mechanism for man-

aging foreign subsidiaries.

Using survey and archival data from 83 foreign subsid-

iaries operating in Belgium with headquarters in 14 differ-

ent countries, we f‌ind that a foreign subsidiary is more

likely to maintain an active board if it is a world mandate

subsidiary. A world mandate subsidiary is a subsidiary

that has worldwide responsibility for a product line and

performs a broad scope of value-added activities. More-

over, a foreign subsidiary is more likely to maintain an

active board if it is larger relative to the MNE, if it has a

higher level of local responsiveness, and if its past perfor-

mance is poorer. Furthermore, the presence of an active

board in a foreign subsidiary is related to other control

mechanisms deployed in the subsidiary. In particular, a

foreign subsidiary is less likely to maintain an active board

if the subsidiary CEO holds a management position at the

headquarters.

To the best of our knowledge, this study is the f‌irst to

empirically investigate the presence of active boards in

foreign subsidiaries. Our results suggest that the agency

problem between headquarters and subsidiary manage-

ment, and the subsidiary’s dependence on the external envi-

ronment are important to understanding the presence of

active boards in foreign subsidiaries. Accordingly, both

agency theory and resource dependence theory are relevant

to the analysis of subsidiary boards and a combination of the

two theories provides comprehensive explanations on the

presence of active boards.

The remainder of this study is organized as follows. In the

next section, we review the literature on boards in stand

alone f‌irms, control mechanisms in MNEs, and subsidiary

boards. In the hypothesis development section, we then

develop hypotheses on the presence of active boards in

foreign subsidiaries. In the subsequent two sections, we set

forth our research method and results. Finally, we conclude

with discussions, study limitations, and directions for future

research.

LITERATURE REVIEW

Boards in Stand Alone Firms

The literature on boards in stand alone f‌irms has been domi-

nated by two theoretical perspectives – agency theory and

resource dependence theory. According to agency theory,

boards should reduce agency problems between sharehold-

ers and top managers (Fama, 1980; Fama & Jensen, 1983).

Boards have the obligation of electing, evaluating, compen-

sating and f‌iring top managers in the best interests of share-

holders (Fama & Jensen, 1983; Zahra & Pearce, 1989). Based

on agency theory, many empirical studies have examined

the relation between board composition (typically measured

by the proportion of outside directors on the board) and f‌irm

performance (e.g., Bathala & Rao, 1995; Brickley, Coles, &

Jarrell, 1997; Wan & Ong, 2005). These studies have reached

mixed results, probably because board composition is

endogenously determined (Adams et al., 2010; Hermalin &

Weisbach, 2003). Additionally, there is a growing body of

literature examining the determinants of board composition

(Boone, Field, Karpoff, & Raheja, 2007; Hermalin & Weis-

bach, 1988; Lehn, Patro, & Zhao, 2009; Linck, Netter, & Yang,

2008; Mak & Li, 2001). These studies suggest that board

composition ref‌lects a tradeoff between f‌irm-specif‌ic ben-

ef‌its and costs of board monitoring, as well as the inf‌luence

of top managers on boards.

In contrast to agency theory, resource dependence theory

views boards as important boundary spanners that make

timely information available to top managers (Barney,

Wright, & Ketchen, 2001; Hillman, Withers, & Collins, 2009;

Lockett & Thompson, 2001; Pfeffer & Salancik, 1978). The

main board tasks include advice and counsel, channels of

information and preferential access to key resources

(Hillman et al., 2009; Pearce & Zahra, 1992; Pfeffer, 1972).

Empirical studies show that board capital such as directors’

expertise, experience, knowledge, reputation, and inter-

locking directorates, is positively associated with f‌irm

performance (e.g., Boyd, 1990; Carpenter & Westphal, 2001;

Dalton, Daily, Johnson, & Ellstrand, 1999; Hillman &

Dalziel, 2003). Moreover, f‌irms respond to signif‌icant

changes in the external environment by altering board

structure (Hillman, Cannella, & Paetzold, 2000; Pfeffer &

Salancik, 1978).

Control Mechanisms in MNEs

An MNE consists of a group of geographically dispersed

and culturally distant units that include its headquarters

and different foreign subsidiaries (Ghoshal & Bartlett,

1990). Headquarters often exerts various control mecha-

nisms over foreign subsidiaries to ensure that subsidiary

management acts in accordance with the overall strategy of

the MNE (Jaussaud & Schaaper, 2006). The literature has

distinguished three broad types of control mechanisms:

outcome control, behavioral control, and cultural control

(Baliga & Jaeger, 1984; Eisenhardt, 1989; Jaeger, 1983;

Ouchi, 1979). Outcome control monitors and evaluates the

performance outcomes of subsidiary management. In con-

trast, behavioral control monitors the behavior of subsid-

iary management. While outcome control and behavioral

control are explicit formal control mechanisms, cultural

control, which is built on shared value and norms to

control subsidiary management, is implicit and informal

(Baliga & Jaeger, 1984; Ouchi, 1979). For example, the use

of expatriate managers and corporate socialization could

build organizational identif‌ication and develop shared

values at the subsidiary level (Chung, Gibbons, & Schoch,

2006; Gaur, Delios, & Singh, 2007; Gong, 2003; O’Donnell,

2000). Cultural control is desirable only when outcome

control and behavioral control are diff‌icult to implement,

because introducing cultural control entails high costs

resulting from initial socialization and continued norma-

tive allegiance (Jaeger, 1983; Nohria & Ghoshal, 1994;

Stopford & Wells, 1972).

Drawing on agency theory, foreign subsidiaries may have

their own goals and risk preferences that differ from those

of headquarters. Empirical studies based on agency theory

154 CORPORATE GOVERNANCE

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