Social norms for fairness and board voting behavior: An experimental investigation

• Published date: 01 March 2021
• Author: Xile Yin,Siyu Chen,Dahui Li,Feng Zhang
• Date: 01 March 2021
• DOI: http://doi.org/10.1111/corg.12353

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Social norms for fairness and board voting behavior: An

experimental investigation

Xile Yin

1,2

| Siyu Chen

1

| Dahui Li

3

| Feng Zhang

2,4

1

School of Business Administration, Zhejiang

Gongshang University, Hangzhou, China

2

Zheshang Research Institute, Zhejiang

Gongshang University, Hangzhou, China

3

Labovitz School of Business and Economics,

University of Minnesota Duluth, Duluth,

Minnesota, USA

4

School of Economics, Nankai University,

Tianjin, China

Correspondence

Feng Zhang, Zheshang Research Institute,

Zhejiang Gongshang University, Hangzhou

310018, China.

Email: nkfzhang@nankai.edu.cn

Funding information

Zhejiang Provincial Social Science Planning

Foundation of China, Grant/Award Number:

21NDJC010Z; National Social Science

Foundation of China, Grant/Award Numbers:

19CGL020 and 19AGL015; Zhejiang Provincial

Natural Science Foundation of China, Grant/

Award Number: LQ20G020004

Abstract

Research Question/Issue: Social norms theory suggests that people voluntarily

defend social norms even when their economic interests are not directly affected by

norm violations. On the basis of this theory, we posit that when managers seek

personal gains at the expense of shareholders, independent directors may be

motivated by social norms for fairness to prevent unfair outcomes. We conducted an

experiment to investigate the roles of social norms for fairness in a board wherein

insiders and uninformed independent directors simultaneously voted in favor of or

against a project with either good or bad quality.

Research Findings/Insights: Independent directors who valued higher levels of

fairness norms were less likely to vote in favor of the project. This negative relation-

ship was higher when insiders had poor reputations. However, insiders were inclined

to vote in favor of the project, regardless of project quality. Furthermore, fairness

norms had a double-edged effect on board performance, which was dependent on

project quality.

Theoretical/Academic Implications: We adapt social norms theory to the board

voting scene with features of group decision-making and information asymmetry.

We find that fairness norms may motivate independent directors to vote against

the project. However, the norm heterogeneity of independent directors greatly

reduces their bargaining power with insiders, which suggests that monitoring

independent directors who are driven by fairness norms has little effect on the voting

behavior of insiders.

Practitioner/Policy Implications: For regulators and firms, we suggest that fairness

norms should be treated as a two-edged sword. The brightness (or darkness) of social

norms depends on the trade-off between gained fairness and loss of board perfor-

mance. Governance mechanisms that can reduce information asymmetry and norm

heterogeneity of independent directors may help maintain fairness in the board while

reducing its negative effect on board performance.

KEYWORDS

Corporate Governance, board voting, experiment, fairness, social norms

Received: 30 January 2019 Revised: 25 September 2020 Accepted: 9 November 2020

DOI: 10.1111/corg.12353

110 © 2020 John Wiley & Sons Ltd Corp Govern Int Rev. 2021;29:110–133.wileyonlinelibrary.com/journal/corg

1|INTRODUCTION

It is generally observed that managers seek to achieve their own

interests at the expense of shareholders in the manager–shareholder

relationship (Hoitash, 2011). This example of an agency problem has

led to many high-profile corporate failures (e.g., Enron) and casts

serious concerns about the effectiveness of corporate governance.

The board is brought to the center of academic research and policy

debates that call for corporate governance reforms (Adams,

Hermalin, & Weisbach, 2010), one of which is that shareholders

entrust independent outside directors to serve on the board as

the dominant majority (Adams et al., 2010; Gillette, Noe, &

Rebello, 2003). For example, both the New York Stock Exchange and

Nasdaq amended their corporate governance policies in 2003, requir-

ing that a majority of directors on the board of a listed company

would be independent directors.

However, independent directors do not receive direct compensa-

tion that is nearly as generous, or performance sensitive, to managers

(Adams & Ferreira, 2008; Jiang, Wan, & Zhao, 2016). Regulators of

many countries (e.g., Australia and China) mandate that independent

directors should not receive equity compensations as it may bias their

decision-making and compromise their objectivity (ASX Corporate

Governance Council, 2007). Therefore, direct compensation may be

insensitive to independent directors' performance on the board and is

insufficient to drive independent directors to work diligently to repre-

sent shareholders; that is, “outside directors are not in it for the

money, or so they say”(Black, Cheffins, & Klausner, 2006, p. 52).

Thus, researchers are intrigued by the factors that drive independent

directors to monitor managers on the board (Jiang et al., 2016).

The concern for reputation is deemed one of the most influential

incentives that motivate independent directors to monitor managers

(Fama & Jensen, 1983). Black et al. (2006) and Gillette, Noe, and

Rebello (2008) also suggest that other “soft”social factors, such as

social norms, may be even more influential than formal structures, pol-

icies, and laws in influencing independent directors' behavior on the

board. However, prior studies provide little direct evidence about the

roles of social norms in board decision-making.

A norm describes a statement that indicates something ought, or

ought not, to be the case (Opp, 2002, 2013). Norms may be enforced

either by people whose interests are affected by norm violations or

by third parties who are unaffected by norm deviations but are in a

position to punish (or reward) the deviant (Coleman, 1990; Jan

Piskorski & Gorbatâi, 2017). The latter are often referred to as social

norms (Bendor & Swistak, 2001; Jan Piskorski & Gorbatâi, 2017).

Social norms can be seen everywhere in human societies, ranging

from norms for fairness, honesty, responsibility, and cooperation to

the use of money and food sharing (Blay, Gooden, Mellon, &

Stevens, 2018, 2019; Elster, 1989; Fehr & Fischbacher, 2004a,

2004b). In particular, fairness norms prescribe that the “cake”of

money units ought to be distributed equally (equality principle), or

equitably (desert principle), among players (Corgnet, Sutan, &

Veszteg, 2011; Konow, 2003; Rost & Weibel, 2013). According to the

Organisation for Economic Co-operation and Development (2004),

fairness should be addressed as one of the most important pillars of

the code of good practice of corporate governance. Moreover, when

it comes to how income should be distributed between the CEO and

stakeholders, “the majority of researchers consider desert (i.e., equity)

to be the appropriate fairness norm”(Rost & Weibel, 2013, p. 353).

The aim of this study was to examine how social norms for fair-

ness affect board decision-making and board performance. We posit

that managers (insiders), who own the private information of a project

to be voted on the board, may seek personal gains by violating share-

holders' interests (Adams et al., 2010; Hoitash, 2011) so that payoff

allocations between insiders and shareholders are decoupled from

their deserts. In addition, independent directors, whose interests are

not directly affected by the agency problem (Black et al., 2006; Jiang

et al., 2016), may be motivated by social norms for fairness and there-

fore prevent unfair allocations between insiders and shareholders.

In the current paper, we report a study using a within-participant

experimental design conducted in the laboratory. We first conducted

a third-party punishment dictator game (TPDG), which was proposed

by Fehr and Fischbacher (2004b), to measure the enforcement level

of fairness norms of independent directors through punishing norm

violators in the TPDG task. Then, we designed another task that

requested participants to vote on a project (e.g., an investment pro-

ject) in which we observed voting behaviors of independent directors

and insiders. The design of the board voting task, similar to that of Gil-

lette et al. (2003, 2008), demonstrated some key features of the real

scenario of the decision-making process by the board. In the task, par-

ticipants were requested to vote in favor of or against a project. The

quality of the project was randomly assigned to be good or bad, and

only insiders were informed of project quality. In addition, insiders

were able to receive private gains by voting in favor of bad projects,

which would harm the interests of shareholders and thus result in

unfair outcomes.

Unlike Gillette et al. (2003, 2008), who assume that independent

directors were always perfectly aligned with the overall benefits of

companies (especially the benefits of shareholders)—that is, indepen-

dent directors preferred to accept good projects and decline bad

ones—we revised Gillette et al.'s (2003, 2008) design by changing the

payoff of independent directors to a fixed amount and introducing

the role of shareholder in the experiment. We specify that it is the

payoff of shareholders rather than that of independent directors that

is correlated with the outcome of the project. This design replicates

the real practice that the compensation of independent directors is

usually not sensitive to their performance on the board and thus

insufficient to make independent directors accountable for their

behaviors on the board (Adams & Ferreira, 2008; Black et al., 2006;

Jiang et al., 2016). The design also helps reveal the influence of social

norms by ruling out the interference of material incentives on the vot-

ing behaviors of independent directors. As the interest of independent

directors is not affected by voting outcomes, independent directors

have no reason to monitor insiders unless social norms are violated.

By observing the effect of fairness norms on voting behaviors of

independent directors and how insiders and the board react to fair-

ness norms, this study helps enhance policies and regulations and

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