The Trouble With Too Much Board Oversight
New research suggests that the most favorable conditions for innovation occur when boards do not monitor the CEO intensely but focus on strategic advising.
The high-profile scandals of the late 1990s have transformed the corporate governance landscape. One of the most notable effects has been increased oversight duties of independent directors. For example, in the United States, under the Sarbanes-Oxley Act of 2002, a public company’s audit committee is now responsible for appointing, compensating and overseeing the work of the external auditors as well as maintaining procedures for whistle-blower protection. The committee itself must be made up entirely of independent directors. Moreover, under rules set by the U.S. stock exchanges, independent directors are supposed to have similar sway over compensation and nominating committees.
These mandates have had substantial effects on corporate boards. First, they have dramatically increased the workload of directors serving on audit, compensation and nominating committees. In a sample of 40 randomly selected Standard & Poor’s 500 companies, these committees held a combined average of 12 meetings in 2000. By comparison, in 2011 those committees met an average of 19 times.1 In addition, the number of independent directors serving on multiple committees has expanded greatly. In 2000, the percentage of S&P 1500 companies in which a majority of independent directors served on at least two monitoring committees was 48%. That percentage increased to 65% in 2004 before settling at 61% in 2011.
The shift toward increased monitoring raises two important questions. First, has the increased focus on board oversight helped to improve the quality of board monitoring? Second, can board oversight become excessive and ultimately detrimental to desirable objectives?
The Benefits of Oversight
The goal of board oversight is to ensure that executives manage their companies in the best interests of shareholders in light of the fact that CEOs and other top executives typically own only a minuscule percentage of their companies’ shares. Effective board oversight can help to achieve this goal by reducing the opportunities for managers to pursue their self-interests at the expense of shareholders. Since board oversight has many facets, we focused on three distinct aspects of oversight responsibility: design and implementation of suitable executive compensation packages; removal of underperforming CEOs; and disclosure of earnings that reflect the company’s true financial conditions. We found that boards were able to perform these functions most effectively when they devoted significant resources to managerial oversight.
1. These numbers are based on an analysis of data in proxy filings with the U.S. Securities and Exchange Commission, available at www.sec.gov.
2. For additional details on these results, see O. Faleye, R. Hoitash and U. Hoitash, “The Costs of Intense Board Monitoring,” Journal of Financial Economics 101, no. 1 (July 2011): 160-181.
3. New York Stock Exchange, “Report of the New York Stock Exchange Commission on Corporate Governance” (New York: NYSE, Sept. 23, 2010). Available at www.nyse.com/pdfs/ccgreport.pdf.
4. R. Leblanc and J. Gillies, “Inside the Boardroom: How Boards Really Work and the Coming Revolution in Corporate Governance” (Mississauga, Ontario: John Wiley & Sons, 2005).
5. Heidrick & Struggles, “10th Annual Corporate Board Effectiveness Study 2006-2007” (Los Angeles, California: Heidrick & Struggles and USC/Center for Effective Organizations, 2007).
6. PricewaterhouseCoopers LLP, “Insights from the Boardroom 2012 — Board Evolution: Progress Made, Yet Challenges Persist” (New York: Pricewaterhouse Coopers LLP, 2012). Available at pwc.com/us/en/financial-services/events/assets/pwc-annual-corporate-directors-survey.pdf.
7. R.B. Adams and D. Ferreira, “A Theory of Friendly Boards,” Journal of Finance 62, no. 1 (February 2007): 217-250.
8. R.B. Adams, “Asking Directors About Their Dual Roles,” Unpublished monograph, University of Queensland, 2009.
9. See Faleye, Hoitash and Hoitash, “The Costs of Intense Board Monitoring.”
10. New York Stock Exchange, “Report of the New York Stock Exchange Commission on Corporate Governance.”
11. See, e.g., Heidrick & Struggles, “European Corporate Governance Report 2011: Challenging Board Performance” (Los Angeles, California: Heidrick & Struggles, 2011). Available at www.heidrick.com/PublicationsReports/PublicationsReports/HS_EuropeanCorpGovRpt2011.pdf.
12. O. Faleye, R. Hoitash and U. Hoitash, “Advisory Directors,” Unpublished monograph, Northeastern University and Bentley University, 2013.
The authors would like to thank Michael Behna and Mahendra Gujarathi for their comments and suggestions on earlier drafts of this article.