Many businesses believe that once they grow to a certain point, they require a board of directors to oversee operations. But a study by researchers at Texas A&M University determined that boards are not as effective at protecting shareholders from executive mismanagement or malfeasance as they are intended to be.
"The purpose of the board is to protect shareholder interests from managers who may not always have the same interests as shareholders," said Steven Boivie, one of the study's authors and a professor of management at Texas A&M's Mays Business School. "For public companies, the board of directors is the highest legal authority of the firm and has the legal responsibility to protect shareholder interests by hiring and firing the CEO, setting the CEO's compensation, approving or disapproving of major strategic decisions, and providing advice and counsel to the top managers."
In a paper entitled "Are Boards Designed to Fail? The Implausibility of Effective Board Monitoring," published in the Academy of Management Annals journal, Boivie and his colleagues argued that the size and complexity of the company, the number of directors and their outside obligations, and "group-level factors" preclude the board from effectively monitoring executive behavior.
In addition, the authors found that lack of information or the inability to properly share that information prevents boards from adequately fulfilling their oversight functions. Moreover, an aversion to challenging executives for fear of making waves oftentimes keeps directors from speaking out against what they might perceive as mismanagement or wrongdoing.
"If we keep insisting that the true purpose of the board is regular monitoring of the CEO's choices, then yes, boards are designed to fail," Boivie said. "Even the most motivated and qualified directors will not be able to consistently watch over the CEO. … If there are structural reasons why boards can't do their jobs effectively, we should stop blaming individual directors for bad outcomes."
Another study published in the Journal of Financial Economics, entitled "Birds of a Feather: Value Implications of Political Alignment Between Top Management and Directors," found that political agreements between board members and executives often causes a lapse in board oversight.
"Alignment in political orientation between the CEO and independent directors is associated with lower firm valuations, lower operating profitability, and increased internal agency conflicts such as a reduced likelihood of dismissing poorly performing CEOs, a lower CEO pay-performance sensitivity and a greater likelihood of accounting fraud," the authors of Birds of a Feather wrote. "Overall, our results suggest that diversity in political beliefs among corporate board members is valuable."
Smaller boards that interact with executives more frequently, the study found, are most susceptible to the negative impacts of a homogenous political environment.
While the potential pitfalls of board oversight are many, Boivie noted that boards' common shortcomings don't entirely invalidate the concept of a board of directors, and that there are still tangible benefits from creating a board to oversee your company. Still, it's important to be realistic about which functions a board can reasonably fulfill, he said.
"We can still count on the board to fire the CEO if the firm does very poorly. But outside of that, we think directors can provide useful strategic advice," he said. "Let's focus on that as their primary role and not expect them to police executives."
In addition, expecting board members to look out for the interests of consumers and employees, not just the shareholders, is probably an unrealistic expectation, Boivie said. He added that he and his colleagues concluded that protection of employees and consumers is best left to government agencies and legislative bodies rather than any particular board of directors.
Boivie's co-authors were Michael K. Bednar and Ruth V. Aguilera, of the College of Business at the University of Illinois at Urbana-Champaign, and Joel L. Andrus, of Texas A&M University.