The Evolution of Corporate Governance: power redistribution brings boards to life

• Date: 01 September 2007
• Published date: 01 September 2007
• Author: David W. Anderson,Stewart J. Melanson,Jiri Maly
• DOI: http://doi.org/10.1111/j.1467-8683.2007.00608.x

The Evolution of Corporate

Governance: power redistribution

brings boards to life

David W. Anderson*, Stewart J. Melanson and

Jiri Maly

To understand the evolving perspectives and behaviour of directors and institutional inves-

tors, f‌ield research was conducted in 2004–2005 by way of a survey with corporate directors in

four countries (Australia, Canada, New Zealand and the United States; n =658) and institu-

tional investors in Canada (n =34). Reported changes in directors’ views and practices are

substantial and consistent across countries, the def‌ining characteristic of which is a funda-

mental shift in the positioning of the board toward becoming a strategic partner to manage-

ment. The role of institutional investors also shifted in ways that are complementary to this

new role of directors (e.g., toward increased monitoring). While most research has focused on

agency concepts of the board as monitors of management, our research suggests that the board

is evolving towards a more collaborative role with management, consistent with stewardship

theory. Our f‌indings also suggest that directors are seeking a balance between collaboration

and their role as monitors of management, rejecting the notion of the board as primarily a

monitoring body. An evolutionary model is offered to explain these changes and implications

are discussed.

Keywords: Corporate governance reform, board of directors, institutional investors, agency

theory, stewardship theory

Introduction

Corporate scandals in the global capital

markets have elicited vigorous debate on

corporate governance. Much of the literature

on corporate governance has focused on

agency theory and the problem arising from

separation of ownership and control (Berle

and Means, 1932; Eisenhardt, 1989). The

essence of the agency problem is that agents

(management) behave in opportunistic ways

that serve their own interests at the expense of

shareholders (Eisenhardt, 1989). One purpose

of the board of directors is to constrain oppor-

tunistic behaviour by acting as monitors of

management.

There has been an on-going debate in the

literature on governance reform and its

eff‌icacy. The debate follows two streams: (1)

improving incentives for top management to

reward desired behaviour (Matsumura and

Shin, 2005; Stroh, Brett, Baumann and Reilly,

1996; Boyd, 1994; Tosi Jr. and Gomez-Mejia,

1989) and (2) improving the board’s monitor-

ing capability through increased board in-

dependence from management (Vafeas, 2003;

Westphal, 1998; Westphal and Zajac, 1998;

Zajac and Westphal, 1994). Our research adds

to the debate by examining how the board of

directors, as an institution, has evolved in the

wake of corporate scandals and concerted

efforts to reform corporate governance.

After the scandals, corporate directors were

derided for failing in their oversight duties

and in the extreme, letting highly paid CEOs

destroy shareholder value. Consequently,

sweeping regulatory change was enacted.

With director accountability in the spotlight,

*Address for correspondence:

The Anderson Governance

Group, Toronto Board of

Trade Tower, 1 First Canadian

Place, Suite 350, Toronto,

ON M5X 1C1 Canada. Tel:

(416) 815-1212; Email:

david.anderson@taggra.com

780 CORPORATE GOVERNANCE

Volume 15 Number 5 September 2007

© 2007 TheAuthors

Journal compilation © 2007 BlackwellPublishing Ltd, 9600 Garsington Road,

Oxford, OX4 2DQ, UK and 350 Main St,Malden, MA, 02148, USA

directors were now expected to become the

impartial arbiters of corporate behaviour and

performance, as demanded by regulators and

investors.

Yet our research shows what actually hap-

pened is rather different and counter-intuitive.

We found that the board of directors is

instead evolving into an active partnership

with management, positioning itself as a stra-

tegic asset to the organisation. This partnership

role is more in keeping with a model of

stewardship (Sundaramurthyand Lewis, 2003;

Davis, Schoorman and Donaldson, 1997) rather

than an agency model of the board as monitor.

Importantly, this cooperative role requires that

the board develop closer ties with manage-

ment. The board’s shift toward the manage-

ment realm might otherwise have created an

oversight vacuum but for the move toward

activism by institutional investors (Pearson

and Altman, 2006; Ryan and Schneider, 2002;

Parthiban, Kochhar and Levitas, 1998; Useem,

1996). We found that investors are engaging

in more active monitoring and demonstrating

a willingness to intervene in the affairs of the

f‌irms in which they invest.

We believe this evolution of the board to

strategic partner of management, combined

with increased investor monitoring, presents

an opportunity to produce a superior gover-

nance regime. The board as strategic partner

can bring differing perspectives to the plan-

ning of strategy, risk management and execu-

tion, potentially leading to better decision

outcomes and improved company perfor-

mance. Further, closer ties to management can

paradoxically serve to enhance the eff‌icacy of

monitoring. Recent work on stewardship sug-

gests that cooperation and closer ties between

the board and management are needed to

counter excessive monitoring and control that

could have negative implications for organisa-

tional outcomes (Sundaramurthy and Lewis,

2003). Additionally, the evolution we docu-

ment could reduce the need for regulation;

increased monitoring by institutional inves-

tors in conjunction with enhanced board

engagement could substitute in some cases for

regulation.

Our paper begins with a brief literature

review followed by an overview of the re-

search. We then discuss our f‌indings with

respect to how the board of directors is evolv-

ing, what we believe is driving this evolution

and the implications of such an evolution. We

follow this with a discussion of the role of

institutional investors and how they too are

evolving and implications of such. We con-

clude with a discussion of how boards and

institutional investors can work together to

strengthen corporate governance and revisit

regulation with the intention to make it more

effective and less onerous. Further, we provide

suggestions for future research directions.

Agency theory, stewardship theory

and public f‌irms

Agency theory has been by far the dominant

paradigm in the literature on corporate gover-

nance and public f‌irms. The agency problem

debate began in earnest with Berle and Means’

(1932) seminal work on the separation of

ownership (shareholders) and control (man-

agement). Since control is in the hands of

managers who act as agents on behalf of the

shareholders, there exists a moral hazard in

which the agents may act in ways that do not

serve the interests of owners (Eisenhardt,

1989). Solutions to constrain such opportunis-

tic behaviour on the part of management

combine a mixture of monitoring and incen-

tives. Monitoring is done to increase the

amount of information available to sharehold-

ers about the behaviour of management while

incentives serve to align the interests of

management with those of the shareholders

to encourage desired behaviour (Beatty and

Zajac, 1994). Both solutions have a cost and it is

the combined cost of the two that represents

the total agency cost (Jensen and Meckling,

1976).

The problem of agency arises from basic

tenets of economic theory in which individuals

are self-interested. Managers are expected to

act in their own best interests that maydiverge

from the interests of the shareholders. This

represents goal conf‌lict (Oviatt, 1988). It is this

line of reasoning that lies behind the use of

incentives to align the interests of manage-

ment directly with those of the shareholders.

The board of directors both performs the

monitoring role and designs the executive

compensation plans that set out the incentive

conditions intended to encourage manage-

ment behaviour consistent with shareholder

wealth creation (Beatty and Zajac, 1994; Boyd,

1994). Thus the board of directors, acting on

behalf of shareholders, controls the agency

cost to the f‌irm. The crucial role the board

plays has brought it, as an institution, under

greater scrutiny in an attempt to understand

its possible contribution to the scandals. Part

of this increased scrutiny involves revisiting

strategies used by the board based on agency

concepts.

Perceived failures in monitoring had led

researchers to suggest that the problem lay in

how boards were structured and the processes

they followed. It was believed that changes

in structure and/or process that increased

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Volume 15 Number 5 September 2007© 2007 TheAuthors

Journal compilation © BlackwellPublishing Ltd. 2007