In the recently published "Governance Gone Wrong? The High Cost of Big Boards", Peter Swan, a professor of finance at the Australian School of Business, reports on his study of 284 major Australian listed companies for the period 2000-2010.
He posits that companies with a large number of Board Directors who have little or no shareholdings in the Company results in less effective board monitoring and weak decision making. His research (together with researcher Serkan Honeine) assessed performance through a comparative analysis of market-to-book ratio of the surveyed companies.
These findings stand in direct contrast to views held by regulators which encourage/ mandate a majority of independent directors on boards, particularly in light of large US corporate failures such as Enron. Under the ASX Listing Rules, a majority of directors is required to be "independent" ie holding less than 5% of stock in the company or not having worked in an executive capacity for the company or another group member for at least three years. The authors say this is "counterintuitive" as it fails to align interests of directors with shareholders.
Moreover, Swan and Honeine question the "independence" and ability of directors to challenge management effectively by the normative effect of the "boys club" where directors want to be accepted and referred for other boards by their peers. This leads to behaviour which is more collegiate, rather than challenging:
"Non-executive directors who are often appointed through friends on the board would be more partial to showing allegiance to their friends and overlook activities by management to expropriate the wealth of shareholders... Paper independence aside, high levels of fixed compensation for attending scheduled meetings, along with the barriers to equity ownership provide for little incentive for them to seek and endorse strategies that add value to a company, as the non-executive directors would re eive little in the way of the fruits for their labour."http://knowledge.asb.unsw.edu.au/article.cfm?articleId=1488
Their findings suggest that while reduced monitoring of management by directors lessens performance, share ownership by directors enhances firm performance. They refer to a "free rider" problem when large boards with "non-shareholding aligned" directors have little incentive to rock the boat.
While the recent spate of cases including
James Hardie,
Fortescue and clearly
Centro would seem to raise the bar in terms of a director's requirement for close participation and monitoring of a business (with some arguing that the bar is raised so high that it almost involves a quasi executive requirement), Swan and Honeine counter that this is not enough without a material decrease in size of the board.
Interestingly, similar results were found by F Cornelli (London Business School) and O Karakas (Boston College) in their study "Corporate Governance of LBOs: The Role of Boards." where they examined the correlation between enhanced performance of companies taken over by private equity and the size and nature of the corporate board. They found that where the board size decreased by 15% and the presence of outside directors was drastically reduced and replaced by individuals employed by the private equity sponsors
, there was an outperformance by those companies to other companies of comparative size and industry. See article http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1875649
On the other hand, there is equally strong argument that the best performing boards are those that work closely with the CEO/ management to encourage a meaningful flow of information - both positive and negative to the board - irrespective of size or "alignment." This is because a board can only contribute effectively where they know what the issues are, and all the competing issues that must be balanced in the process.
It is clear that there is no definitive best practice for board composition which can be legislated. However, where there are interested and well informed board members, with an effective chairman who encourages and supports management to bring all relevant information to the board, these boards will be more effective than any board which is simply mandated for "size" or shareholder alignment. It will be interesting to see in a post Centro environment, whether the evidence will show that a smaller board can achieve these results more effectively than the larger board.
