According to The Telegraph, corporate governance is having its moment in the sun: “The global financial crisis has made the public much more aware that what is going on in the great business corporations is of real importance.” Recent scandals such as the Volkswagen crisis have brought a sense of immediacy to corporate governance, increasing investor awareness of the impact of a board of directors.
The increased attention has not necessarily accompanied increased clarity around the role of a board of directors in corporate governance. In a public conversation that largely focuses on the structure of a board, David F. Larcker and Brian Tayan of Stanford University claim that a board’s processes have a greater impact on the direction of a company. Larcker and Tayan explore the most prominent myths around boards of directors in an article published by Stanford Graduate School of Business and the Rock Center for Corporate Governance at Stanford University:
Myth 1: The chairman should always be independent.
“Despite the belief that an independent chair provides more vigilant oversight of the organization and management, the research evidence does not support this conclusion….Additional research actually found that forced separation is detrimental to firm outcomes: Companies that separate the roles due to investor pressure exhibit negative returns around the announcement date and lower subsequent operating performance.”
Myth 2: Staggered boards are always detrimental to shareholders.
“While it is true that staggered boards can be detrimental to shareholders in certain settings — such as when they prevent otherwise attractive merger opportunities and entrench a poorly performing management — in other settings they have been shown to improve corporate outcomes. For example, they benefit shareholders when they protect long-term business commitments that would be disrupted by a hostile takeover or when they insulate management from short-term pressure, thereby allowing a company to innovate, take risk, and develop proprietary technology that is not fully understood by the market.”
Myth 3: Directors who meet NYSE independence standards are independent.
“Just because a director satisfies the independence standards of the New York Stock Exchange does not mean he or she behaves independently when it comes to advising and monitoring management….The researchers discovered that board members who share social connections can be biased to overly trust or rely on CEOs, regardless of whether they’re considered independent by NYSE standards.”
Myth 4: Interlocked directorships reduce governance quality.
“Interlocking creates a network among directors that can lead to increased information flow, whereby best practices in strategy, operations, and oversight are transferred across companies. Network effects created by interlocked directorships can also serve as an important conduit for business relations, client and supplier referrals, talent sourcing, capital, and political connections.”
Myth 5: CEOs make the best directors.
“Studies have found no evidence that a CEO board member positively contributes to future operating performance or decision-making and finds CEO directors are associated with higher CEO pay. Additionally, a survey by Heidrick & Struggles and the Rock Center for Corporate Governance at Stanford University finds that most corporate directors believe that active CEOs are too busy with their own companies to be effective board members.”
Myth 6: Directors face significant liability risk.
“Directors are afforded considerable protection through indemnification agreements and director and officer liability insurance. Indemnification agreements stipulate that the company will pay for costs associated with securities class actions and fiduciary duty cases, provided the director acted in good faith. Insurance provides an additional layer of protection, covering litigation expenses, settlement payments, and, in some cases, amounts paid in damages up to a specified limit.”
Myth 7: The failure of a company is always the board’s fault.
“Even within the scope of its monitoring obligations, a board won’t necessarily detect all instances of malfeasance before they occur. The board has limited access to information about the operations of a company. In the absence of ‘red flags,’ it relies on the information provided by management to inform its decisions.”