CoRPORATE GovERNANCE

a.
0

l< N O W L E D G E O B J E C T I V E S

After studying this chapter, you should be able to

Explain the ro1e or me board of directors

4. ldentify voice-based and exit-based governance mechanisms and rhe
combination as a package , ,
,,
5 . Acqu ire a global perspect1.ve on how governance mechanisrns vary arounL:i [lt'\ \ '
6. Elaborate on a comprehensive model of corporate govemance
7.
Participate in three leading debates concerning corpora te
8.
govern...incc
Draw strategic implications for action

380
 High Drama at Hewlett-Packard (HP)

In the late 1990s, something strange happened to HP-

pay im.$30 m.illion . in 2009? And why was it reportedl
the equivalent of a deranged hairy-bellied scientist getting
cons1denng paying h1m $ 100 million to stay on for
hold
anothe three years?
of the company's DNA and adding a dangerous dose of The problem for HP is that Mr. Hurd deserved his
Hollywood flakiness. The HP story suddenly acquired some money more than most other chief executives. The ü
unexpected new ingredients: a board room coup (Carly ·pany's share price doubled on his watch. HP sped past JB
Fiorina was brought in as the first female chief executive to become the world 's largest information technolog-;(IT)
of a Dow-30 company but was tossed out after the com company by revenues. lt also became the first rr compan
pany lost half its value); a corporate spying scandal (Patricia to have sales of more than $100 billion. Mr. Hurd restored
Dunn, the company's chairvvoman, was also binned after it HP to its former glory as the world's biggest maker o.+
personal computers . He prepared the ground for furH1e
emerged that she had used a private security firm to spy on
growth by putting together a succession of multibilliori
board members and journalists); and obscene pay packets
dollar deals, snapping up Electronic Data Systems (EDS„
(Ms. Fiorina was paid more than $20 million to leave). 3Com, and Palm. And he did all this while squeezing cos-
The company did its best to rid itself of its new Hollywood t.S.
DNA by appointing Mark Hurd-a nerdy-looking numbers HP is now struggling to fill not one but two top posi
6
guy-as chief executive in 2005. But on August · tions: Mr. Hurd doubled as chief executive and chairrnan
2010
· th.e (despite pointed warnings from corporate reformers). His
news broke that Mr. Hurd had more than numbers on his abrupt departure also leaves HP grappling with
. . et tered the HP story. innumerable
m1nd. Two more 1mprobable chara ers enorn and B-mov1e.
ft
One was Jodi Fisher, a former so core- P questions. Why exactly is Mr. Hurd leaving? Ms. Fisher says
t vents for HP. T he that the two never had sex and that her complaint againsi:
actress who had helped at corpora e e h h d
him-about which she remains tight-lipped--was settled
other was Gloria Allred, a Los Ange 1
es lawyer wy o a
Spears
. 8
· h J Simpson · n1ne o ' without a lawsuit. The board's charge sheet on Mr. Hurd
previously locked horns wit · · . d ' ·d stories of
d res1gne am focuses on dodgy expense claims. lt is all rather confusing.
and Tiger Woods. r. ur 1 nd HP saw
M 1·ttyH se reports-a lf his ethical lapses were serious, then why is he being
sexual harassment and expen given a
. t k market value golden parachute of $ 12.2 million? And if they weren1
.$1O billion wiped off Silicon Valley serious, then why is the company getting rid of a star chief
its s oc 1
the
Where does this psychodrama eave k ago said senior executive? Larry Ellison, Oracle's chief executive, calls it "the
·1was a wee , worst personnel decision since the idiots on the Apple
giant? Pretty much where f the . board, sa
1 1d
a member o
figures. Marc Andreessen, " Cathie Lesjak , board f ired Steve Jobs many years ago."
the ne peon.
0 h
that "HP is not about any . d that, althoug
. . h" f execut1ve, argue . . . t. e Soitrce: Excerpted from Eco110111 ist, 2010, The .:urse of HP.
company's intenm c ie " e "didn't drive our in1t1a iv .
"Mark was a strong leader, h . H rd was "only one August 14: 54.
hdrove that." But if Mr. u d whY did
T HPcompany
e y was what mattere , 111111 11111111 111111111111111111111111111111111111111111111111111111111111111111111111111111111
person" and the compan
11111111111111111111111111111111111111111 1111111111111111111111111111111111111111111111
111111111111111111111111111111111111111111111111

operations of a firm .

c.hief exec.utive
offic.er (CEO)
The top executive in
charge of the strategy and
 p' s high drama did nl end
afler. MarkHULxl 's
rcsignnHon in August 20 1.
0.

H
In November 20] 0,
1ls boarcl h1red
Leo Apot heker ,
lormer chief
executive off icer
(CEO) of SAP. as
H P's new Cl30.
Uut in September
201l the board
fired hirn al er HP lost $30
billion in m urkel capit uli:t.ulion
during his short tenure.
381
PART 3 C O R PO RA TE - L EV E L STR A TE G IES

F I G U R E 11 .1 The Prima ry Pa rticipa nts in C orporate Governa nce

Board of Directors

Owners Managers
e

For Apotheker's less than 11months of service, he walked away with $13
million: severance payment of $7.2 million, HP shares worth $3.4 million, and
a perfor mance bonus of $2.4 million. In September 2011, Meg Whitman, an
HP board member and eBay's former CEO, was named HP's newest CEO-the
fourth CEO since 2005 and the seventh since 1999.
While HP's high drama is an extreme case, it raises a series of questions
affecting many frrms: What is the most optimal way to govern corporations so rhar
investors will reap returns? What is the proper role of the board of directors? Hoff
should CEOs be properly motivated and compensated ? These are some of tht'
key questions addressed in this chapter, which focuses on how to govern rbe
rporate corporation around the world. Corporate governance is "the relationship amo
governance
e relationship among various participants in determining the direction and perform ance of corporations.
rious participants in The primary participants in corporate governance are (1) owners, (2) managers, · .J
etermining the direction
nd performance (3) board of directors (Figure 11.1). This chapter first discusses the primaf)' partic
of
orporations. pants. N ext, we cover tern al and external governance mechanisms fr .1 alob·
m· 0111 l
' ::>
perspective, followed by a comprehensive model drawn from the strateg)' triplll ·
Debates and extensions follow.

Owners . t'\ ir:

ttt'f'll
Owners provide capital, bear risks, a nd own the firm.2 Three brand pa -::hi!"
, <' 1
111
(1) concentrated versus diffused ownership, (2) family ownership, n nd (3) st:itc 0 '

concentrated ownership and control

Ownership and control
rights concentrated in Concentrated versus Diffused Ownership . ferred eo
the hands of owners. Founder s usually start u p firm s and compl ct:cly own a nd con t rol them. Thfisi is raespl.fes 1"0
as concentrated ownership and control. Howcver, a t some pom· t , 1·r th. e h n d s 11T·JJIJI ]1 '
1 1

grow and need s more capi tal, th e owners' desire to keeo the firm in family an

to accommodate the arrival f
diffused ownership and 90% of listed UK c1:.rrms aor other shareholders · Appro x1. mate J y 80o/c f 1.
small sharehold
An ownership pattem
separation of ownersh"
involving numerous srnall
shareholders, none of shareholders and con:oi"s
whom has a dominant managers who own little (or no :u onc trated in. the hands of salaried profs:sional
\evel of contro\.
separation of
ownership
and control
The dispersal of ownership
among many small
shareholders, with control
of the firm largely
concentrated in the hands
of salaried, professional
managers who own little
or
no equity
.
Chapter 11
Corporate Governance 383
b e now characterized by d"ff d o o i s ted US firms
ers ut non ·h use ownersh · h ·
1
wit a dominant level of control 3 I ,fjw1t numerous
;
1 •:;•I,
in that ownership is disere":'m0
tyd
' :,:,S.
(by d1spersed shareholders) and daq-t short, th1s refers to separation of ownership
If majority or dominant y o- ay control (by managers).
owners (such as fo d ) d
are naturally interested in keep· 1 un ers o not personally run the firm, they
mg a c ose eye on how th fi ·
owners, each with a small e run. However, dispersed
stake h .th . . 1rm is
shareholders do not b th t , ve ne1 er mcentlves nor resources to do so. Most small
. o er o s ow up at annual shareholder meetings Th refer to
free nde and hope that other shareholders will properly monitor and disciplin;i:an
If small sh.areholders are not happy, they will simply seil the stock and ;0vest elm:: :
However, if all shareholders behave in this manner, then no shareholder would care and
managers would end up acquiring significant de facto control power.
The rise of institutional investors, such as professionally
4
managed mutual funds and
pension pools, has significantly changed this picture. Institutional investors have both
incentives and resources to closely monitor and control managerial actions. However, the
increased size of institutional holdings limits the ability of institutional investors to <lump
the stock. This is because when one's stake is large enough, selling out depresses the share
pric e a n d h a rm s t h e se ll er . . .
W h i le t h e ir na g e o f w id ely held corporat1 0ns i s a reasonably accurate
. .
descn pt1 0n of
most modern !arge US and UK firm,, ;t ;, not the case ;n other parts of the .wor!d.
Out,;de the Anglo-Amerkan wor!d, there IB relatively little separanon of ownwhlp "';d
rnntrol.
ically owned and controlled by families or the state. Ne1.:, we
fi are typ
Most 1arge irms
turn our attention to such firms.
=
FThaemvial'yt moawjornitey rosf h!airPge firm' throughout wntffient"1 Eurnpe, Asfa,
Latin Arnerica and performan"· lt may al'° mUtintize the wnfüct'between ownm wd
profe<filon.f
Afoc> foatwce ncentrated family owne<'h;p and wntrol. On the poo;tive00,;de, fumn,.
owner'h;p and0w0 ntrol may prov;de better ;ncentiv<' for the firm to lono-t ·
fow'
ager' ryptioallY enwuntered m w•dely owned finm. Howmr, on the negative ,;de, furoilv
owner'h;p and trol may Jead to the ,electmn of Je" quaHfüd nrnnagers (who happe
to be the ,ons. 0d0a0ughte"·and relanves of founder<), the destruction of 'n!•>< b<cau« of
familY n;cts. and the epropriation of m;nority .shareholder< (<fucn'5ed later). At
P""n ,000 is no conclus1ve eVldence on t he pos1t1ve or negative rolo ot· .:, " il
. ' " ""
own- y
. t thdecreontrol on the performan ce of lar ge firms.
ership an
,.,· p
State OWJ1 s 1 hestate is another major owner of fi.rms armmd the world. Since the
Other than [arnihes, es-ranging from ßritain to Brazil to Bela rus-realized that thei.r
1980s, rnan Y countrrises (SOEs) often perform poorly. SOEs typically suffer from m1
state-owne d enterpA l though in theory all citizens cludm. g employees) are owners, in
(m .
incentive prob1el11·

384 PART 3 CO R P ORATE-LE VE L STR ATEG IES
agency relationship
The relationship between
principals and agents.
pri ncipals
Persons (such as owners)
who delegate authority.
agents
Persons (such as
managers) to whom
authority is delegated.
agency theory
The theory about
principal-agent
relationships (or agency
relationships in short).
principal-agent conflicts
Conflicts of interests
between principals (such as
shareholders) and agents
(such as professional
managers).
agency costs
The costs associated with
principal-agent relation
ships. They are the sum
of
(1) the principals'
costs of
monitoring and controlling
agents and (2) the
agents' costs of bonding.
information asymmetries
'-......
practice, they have neither the rights to enjoy dividends generated from SOEs (
shareholders would) nor the rights to trans1cer or sell "th ei·r » property . SOEs are de
facto
owned and controlled by government agencies far removed from ordinary citizens and
employees. Thus, there is little motivation for SOE managers and employees to improve
performance, which they can hardly benefit from personally. In a most cynical fashion
SOE employees in the former Soviet Union summed it up well: "They pretend to pay u;
and we pretend to work." A wave of priva tization hit the world since the 1980s.
However, SOEs staged a spectacular comeback recently. In 2008 , many governments
in developed economies nationalize d major firms ranging from General Motors (GM,
which reads "Government Motors") ·to Royal Bank of Scotland (RBS) in order to
prevent massive bankruptcies and job losses.
Managers
Managers, especially executives on the top management team (TMT) led by the CEO,
represent another important group of players in corporate governance.
Principal-Agent Conflicts
The relationship between shareholders and professional managers is a relationship between
principals and agents-in short, an agency relationship. Principals are persons (such as
owners) delegating authority, and agents are persons (such as managers) to whom authority
is delegated. Agency theory suggests a simple yet profound proposition : To the extent that
the interests of principals and agents do not completely overlap, there will inherently b
principal-agent conflicts. These conflicts result in agency costs, including (1) the
principals
costs of monitoring and controlling the agents and (2) the agents' costs of bodin
7
(signaling their trustworthiness). In a corporate setting, when shareholders (principal:
are interested in maximizing the long-term value of their stock, managers (agents) may e
more interested in maximizing their own power, income, and perks.
Manifestations of agency problems include excessive executive compensation , on-d1
.b
-;
consumption (such as corporate jets) , low-risk short-term investment s (such as maxim ue
current eamings while cutting long-term R&D), and empire-building (such as vcEO
destroying acquisitions). Consider executive compensation. In 1980, the average VS . ies
. . 400 tul .
eamed approximately 40 times what the average worker earned. Today, the ratio is Jirin
Despite some performance improvement, it seems difficult to argue that the avei ervd
CEO improved performance 10 times faster than her workers since 1980 and thus
the salary of 400 workers today. In other words, one ca. n "smell" some agency. cos(ts. d h<tif·
Directly measuring agency costs, however, is difficult. In two most m· novat1vCe EaOn
r1e11t1P·
raising) studies to directly measure agency costs, scholars find that some sudden. of u1e1r
(p1ane crashes or heart attacks) are accompanied by an increase hare pn
. s b droPP'J. J",,
ces
m
Asymmetrie distribution of information between two
firms.s These shareholders had to sh0ulder d Y. ,]Jeit tJ1 )' dead (!). Conversely, we could imagine how
CEOs reduced much value these CEOs dest1·oyedies'. .
agency costs had been alive. The capital market, sadly, was pleased with such human U:age syrrur1etrieS
Th · f· f atron aa]ways 1„101v
that b tw e pn mary reason agency problems persist is beca use o rn orm iv
e een pnnc1pals
· · and agents-that is, agents such as managers a Jmost ·bJ ro red11 ce
sides.
more ab out the property they manage than principals do. Whi.le 1· t P ossi e
1 ·5
 Ch a P t e r 1 1
in1formation asJ'!nmetries throu c o r po r a t e G o ve r n a
385
1 nce
. · gi governance rnecban · . .
e Inunate agency probJems. JSrns, 1t /8 not reaJistic to completcl y
Principaf-Principa/ Conflicts

Since COncentrated OW!Jership •nd controJ by fa milies is the norrn in rnany parts of
the wor]d, different kinds of conflicts are at pla y. One of tbe leading indicators of
concen. trated family OW!Jership and controJ is the appoin tment of family members
as board
chairman, CEO, and other TMT members. In East Asia, approximatel y 57% of the
nceonrporations have board chairmen and CEOs from the controlling f amilies.' In conü-
10
tal Europe the nwnber is 68%. The families are able to do so, because th?'. ae
the M urdochs,
b an . A . 11 1)
controlling (al'though not necessarily ma;·on·ty ) hshJdarehoJd ers etForird eoxfamp e, at
1
news
Corporation, neither the oar nor gry share o ers can b
d
who are controlling shareholders (Strategy m ct10n . .

::: .::::: l- ".: -_;- „'· : - - .. -

]:1'. < lf[Clj l' fif;Mt M1

,;'!,.::;.e; ' +Jfi > - .,.' - -
-
<

The Murdochs versus Minority

Shareholders
Founded in Adelaid .
short Ne e, Austral1a, News Corporation (in Group, a London-based media studio owned by Ruperrs
' Ws Corp ) daughter Elisabeth Murdoch. While Shine produced some
and listed · IS now headquartered in New York
·

Australian :N DAQ with secondary listings on the hit shows such as NBC's The Office and The Biggest Loser,
conduct f . cunties Exchange . While the unethical minority shareholders alleged that News Corp. overpaid for
i·n 20 o 1 ts B · · h Shine with 13. 1 times Shine's $45.6 million in eamings
11 h ' n ti s tablo1.d operations rocked the before interest, taxes, depreciation, and amortJzauon
world
enjoys et is as not the first time News Corp., which Proiect ibit B: .'n 2007, Rupert M_urdoc pursue DW
contro orting controversies of others, stirred up Jones by pay1ng a rich $5.6 bi/11on pnce to b . y t
how Rvers1es itse lt . A consistent theme of controver the
\\tish ' PUblisher of the Wall Street Journai-agains d ·ce
s1.es 1.s
shar h upert Murdoch and his family as contro/ling
e ol der t . .
Ex . s reat m1 non ty shareholders .
becarn:ibit A: In 2003, the 30-year-old James Murdo.ch
broadc CE of BSkyB, Europe's /argest satellite
resist aster, in the face of /oud minonty shareho/der
350, ance. The reason 7 James' father Rupert controlled
'0 of BSk
Exh· . YB equity . and control/ed the boar
d · a et
 (EBITDA). In contrast, Apollo Global Management, ro 1awsu1 1 .
block the sale. The cornplaint alleged that:
a leading private equity firm, paid $510 million to
purchase American Jdol owner CKx, a deal valued at 8.5 Murdoch did not eve11 pr ete11d tltert• was 11 1·alid stmtc\
times CK:<'s >ic purpo se Jor News Co1p. to buy Slt im·... Tlte
trimsach'or;
0 i.". a naked and selfish e11dea vor by
$ .23 million in EBITDA. Frustrated minonty shareholders
6 as Amalgamated Bank and other pension funds filed M11rdod1 toji 1rtlwr ill}iise the upp er ra11ks of News
s C ·
a ·t ·n Delaware (where News orp. 1 s reg1 ster l
· ed h with ltis o_ffeprin g.
Co1p.
Of numerous m1. nority and then-afarvn1ily
1 011 ( I ) B/ 00111bt'1:i: llusi11<'s..<w,·,·/.„ 2011. \\'ill th<'
Peeste of shareho/ders
/))e"'b r Cherni·n, News Corp. pres1·dent a nd a wrote sou rces·· Base< "f llrdodi? Jul y 25: L S 20; (2) F.wu1m1<1, 2011.
no
do„..,, e. r · The upshot7 After four months , N ews cor.p.left scanc1d· J uunet·,··cnds .111d a!it•1nlt<' p•·opk. Ju.ly lt>: 25-2-; (3)
•vn lts. Value by $2. .8 billion and in 2009 '.( hern1n (orp.
.
J-IoW
(0 lose II ' '
·. 201 l. La>t of tht' 11w uls, July •.>: II,
>,

annoExh1b't ' ct1on f'cono1111:,t 111111111111111111„„ „„111111111111111111111111111111111111111111111111111111 11111111

1 C: In 201 1, in a re lated transa
NbeUWYS shine ,

1111 Unced that it would pay $673 rn1//1on to „„„111111111111111 11'"""""""""

111111111111"""""' "' "
1111111111111111111111111111111111111111111111111 11111
11111111111111
386 PART 3 C O R POR ATE -LEV E L S TH ATEG IES

principal-principal
conflicts
Conflicts of interests
between two dasses of
principa\s: contro\\ing
shareholders and minority
shareholders.
expropriation
Activities that enrich the
control\ing shareholders at
the expense of minority
shareholders.
The Murd och casc is a classlc cxam pl c of th c confl icts i n fam i l y-owned and fa mil
controlled finns. lnstead of betwccn pri n cipals (sh arch ol<lcrs) and agen ti; (profe<,sionJ
mana gers) , the prima ry confücls arc bctween two dasses of pri ncipal c;: c<mtrrillin
shareholders and minority sha reholders-in other words, principal principal conflirl, (
(Figure 11.2 and Table 11.1). Family managers such as the Murdoch s, whr, repre
are) controlling shareholders, may advance family in terests at the expense of mm
shareholders . Controlling shareholders' domin ant position as both pri ncipals and
(managers) may allow them to override tradition al governance mech anisms d
curtail principal-agent conflicts such as the board of directors.
A manifestation of principal-principal conflicts is that family managers mai
potential to engage in expropriation of minority shareholders, defined as activities th
FIGURE 11.2 Principal-Agent C onf licts and Principal-Principal Confhc:s

Minority
sharehold ers

PrincipaJ- agent
confücts Profession:ll
manager>

Minority
shareholders

Principal-principal
conflicts Emul)
111.1n.11. r>

„„ „„
„ „„„„ „„
„„„„„ Fa1nil} 111.11ug, 1, .uv

„... „„ „„„„„ .1ppoiut1.'d by nHll[Oll 11'g

Cont roll ing
,h.11dtl>kk 1'
sharcholdcrs

-- • _!1llt.."
,<·,ur rre: A c1a ptci;1 from M . Young, M . \V . Pi•ng. D. Ahlstt om.'•. 1>' '.I )l,uI l ·><•''"'1•''
·
1 11t.m , '
C
orporn1c govcrna n1.1.• in cm1.'q.\lng 1.•conomh·s: A 11•v1. t•w ol• t 1w p11.1w1.p.i l · 1•1 llh 11'•1 1
(p. 200), Ju1m11il of Mu11ow1111•11t Stw lfr . . •I S: 1% no.
 Chapter 11
o r p (J r a tr! 1Hi •1e r n iJ n c

Ownershi p
pattern

Manifestatio'ns Strategies that benefit entrenched

Strategies that bene"
managers at the expense of shareholders (suchatas shirking, exces
shareholders tr shareholders (s
building).

l nstitutional Formal constraints (such as courts) are

protection of more protective of shareholder rights. informal norms adhere to s
minority wealth maximization.
shareholders

Active, at least in principle as the

Market for corporate control mechanism of last resort. "
"governance

Source: Adapted from M. Young, M. W. Peng, D. Ahlstrom , G. Bruton, & Y. Jiang, 2008, c
governance in emerging economie' A review of the principol-principol per,pe<rive f p. 10n
of M anagement Studies, 45: 196-220.

controlling shareholders at the expense of minority shareholders. For e<. :rm"

agers from the controlling familY maY simply divert mources 6-om th/;:;
personal or [arnilY use. T12his activity his"vividlYi·nic"km( uftned k"ntunneling "-di-
m
ggin<- ,"r"u.nn c. '°
tunneling to sneak resources ut. While suc tunne •ng o en · own as "corporat< thctl"' ,.

Äctivities of rnanagers from illegal, expropriatio0n can be legallY done through related transactions. whmt-r "-'"
the controlling family of a trolling owners buy fir01 assets from another firm they wn "',:'bcwe-market .prk<s or
COrporation to divert
. r orate overna n ce
1L I
and """'' P'"'"'
spin off the rnost profitabIe part of a pubhc firm ,rnd n.erg<' •I "oth auother F"'"tdiim
u·"huon.tllv tc us'"' """ h
resources frorn the firm of theirs (see Strategy in Action ). . .• „ . . .
for
Personal or farnily Overall, while eo P g beeanse of 1he S<'I"""""" ot """"'h•F a nJ conrrol in ,
use.
related transaction o contro pro1essional manage<' to' gnvco·n h.nn•I.Y """"'ge<S ·'" '•"'"' "'•''h
maJonty o v an f
'''"'"''tr"'"
r J rob·ibly luhl.'t u11pl1rwn- · rh..- ,11l1lui.I \;"tu+

1
Controlling owners sell . . 1 f ... rs d l)!< ft·rms. wqwua 1 • • . 1 1 . '•
firm t
n 1 .
1 '
assets to another firm ownership and contr Nt'"'$ l 1.11 p1. r• w.111) .
they oWn at be\ow-rnarket ' 01
JS 0
1 U v.r- -1flllS, 'lll J1 1s

Prices or spin off the with

most rofitab\e Part of a
pub\ic firm and rnerge it
(including in certain VS
an(. irectors .. ,„..'""" .„ ·""""'" o..,„.,,,
!1l1lrorntsh.er of their ard Ü ,ow
•eil ." "'"I """ ",',,.'."'j .,„,t ,1 "'W"·")'
private f t><n•li•<> topi
D
·
n , . ., 11, ' •

B0 .
· t rfl1ed i a
r y bei '" t:
· 1s
1 i·v•1hi.1ti . •
11n<
------------ As_an_,,_tiinfie·es stra tegJ·r dcci 10J ,
-
388 PART 3 CO R POR A TE - LEVEL S THATEG I E S

inside director
A director serving on a
corporate board who is
also a full-time manager
of the company.
outside (independent}
director
A non-management
member of the board.
Board mposltion
Othervvise known as thc insiclcr/ou lsid er m ix, board com position has recen tl y attract
d significant attention. Inside directors are top executives of the firm. The t rend arou nd
1 world is to introduce more outside (Independent) directors , defined as n on-
manageme members of the board. Often ideally labeled "i ndependent directors," outside
directr1rs
presumably more independent and can better safeguard shareholder interests.
Although there is a widely held belief in favor of a higher proportion of
directors, academic research has failed to empirically establish a link between
13
sider/insider ratio and firm performance. Even "stellar" firms with a majori
directors on the board (on average 74% of outside directors at Enron, Global
and Tyco before their scandals erupted) can still be plagued by governance pro
the world's largest financial services firms, the more outside directors on their b
14
worse their stock returns during the 2008 crisis.
lt is possible that some of these outside directors are affiliated directors who
family, business, and/or professional relationships with the firm or firm manage::::er.:. ·
other words, such affiliated outside directors are not necessarily "mdependen ."

Leadership Structure
Whether the board is led by a separate chairman or by the CEO who docoies -
CEO duality chairman- a situation known as CEO duality-is also irnportant. From an agencv ::2:-
The CEO doubles as D. standpoint, if the board is to supervise agents such as the CEO, it seems impe.ca::ve
chairman of the 0: the board be chaired by a separate individual. Otherwise, how can the CEO be
board.
evi==- by the body that he/she chairs? In other words, can a schoolboy grade his
own c?:S
However, a corporation led by two top leaders (a board chairman and a Cf ü) rncy '..ic. .!
unity of command and experience top-level conflicts. As a powerful executiw. J L_::'-_'
obviously does not appreciate being constantly second-guessed by a board chairrnilil· >,c.
surprisingly, there is significant divergence across countries. For instance, while ..i mJi.L'n"
of the lrge K firms separ_ate the two top jobs, many large US fums cobine_
A pract1cal d1fficulty often c1ted by US boards is that it is very hard to w.Twt J 1.. JF ·
l
CEO without the board chairman title.
Academic
· 15
research is inconclusive on. whether CEO duality '
(or non-du.uity)
.
is, "·o
tnc'
t c'L"
effect1 ve. However, pressures have an sen around the world for firms to sph t thc t . :
to at 1east sh ow t h at t h ey . l [ J% L'( [
senous about controlling the CEO. In 2010,Il" L1 - , .,
are
. h , " 'f1.." t· n rJ :
new CEOs ar0un d the world were also appomted as chnirmen . In 2002, t c r '- l t '" '"
was 4.s:o. Even in U firms that typically favor CEO dunlity, Standa rd. & PQ1.1r's 3Vl
practlcmg CEO duahty fell from 78% in 2002 to 59% in 2010. Lt>

Board lnterlocl<s
D. d l , l . l l' h l ''Ll"t' 1.i
• - III 11.td ." " lJC'
l' • ,
h ,· r ( .
1rectors ten to )e econonuc an( socia e ites w o s 1a rt' a s1.: t 1. ,1f • •t ll
· L,c
11 1
interlocking directorate recJ' prOCJ' t)'. 1 7 \A.,f }1en one person a t"t1'l i" ate( l w1't h 01w t'1nn st't s on tl1t' b·Ll •1rd. \.) ·•h i "
Two or more firms
share t ht<>t'.:-
c
a n lnterlocking dlrectorate hns bccn created. Firms ofkn ·st•Il1l.1s,1t n..l•l tl.llllt r t1r t.ton ,_,r,.,!,
1l
one director on su )Oard appoint mcnt s. For inst aw;c, outside lire1.c't{ll'S t,rom t'm,u 1'-n' l tO.:J-J' rif
their w th 1

boards. facilitatc financing . Outside d ircctors expcrit..'nced in .wq uisit ions ma)' help
engage in t hese prnct lccs.
 C h a pt e r 1 1
C o r p o r a t f G rJ/ r n a n cP 3 8 9

In the United States Frank Car·lL · f , ·

' 1 c c 1 , a o r m c r S c crc ta r y o f
man of the Carlyle Grou
1 J cfcn1c a n d chair - p (a leading p r i v a te c q ui t y fi rm ), s c rv cd
on bo a r d1 at
20 (!)
one time. In Hong Kong, the tnost heavily con n ccted d i rector, Da vid Li,
chai rman of the Bank of East Asia, sat on nine boards." Cri ti cs arguc that
mh directors ar unlikely to effectively tnonitor tnanagement. In fact, on e of thc
board1 Da·iid Li sinecrvreeadsionnglwy arsarEen. ron's. In the post -Enron
environmen t, such un u1ual practim a re

The Role of Boards of 0t.rectors

In a nutshell, boards of directors erform (1 .
acquisition functions Boa d , fü . ) control, (2) service, and (3) re
. . · r s e ecttveness m serving the control function stem
their mdependence, deterrence, and norms. Specifically:

• The ability to effectively control manager s boils down to how independent directors a:e.
Outside directors who are personally friendly and loyal to the CEO are unlikely to
challenge managerial decisions. Exactly for this reason, CEOs often nominate family
19
members, personal friends, and other passive directors.
• There is a lack of deterrence on the part of directors should they fail to protect
shareholaer interests. Courts usually will not second-guess board decisions in the absence
of bad fairh
or insider dealing.
. ent directors have few norms to draw on. Directors who
• When challengmg managem ' . th CEO ·n meetings tend to be frozen out of
boarc "stick their necks out" by confrontmg e i

deliberations.

ad I n addihtion to control, another important function of the .

bo ar· d ·· 20 IB sem re-- · aril
VlSmg• t e CEO. ally, another crucial board function is resourc e a · · · pnm Y
Fm
foc 1 fi ft , , . cqWfilboU for ffi
a irm, o en through mter!oclcing dl!ectorates-" e
Overall, until recently, rnany board s of directors simply "rubber stLamcns1•s•
(approve without scrutiny) managerial actions. Prior to the 1997 econonu·-L.!
• V

piIO_ellS many South Korean board s did not bother to hold meetin<S and boa<d
de...; " ' were Hterally "rubber starnped"-not even by d>fectors thernsdves. but by
corpor."'
secretaries who starnped the seals of all the _d"ectors , which were kept in me
corporate office. j-low ever, change is in the al! throughout the world. In Suuili
. gs are noW regularly held and seals are personallv tunped b,·
orea, oar mee tin · • ' ,

b d 22
K
the directors thernselves.
. fc tivelY bein g " Jucd<" " "'" ut th< onu>t <len»u>clin<
Direc:tirl9 Strategicall}f . „„ . „ , . , .
oar s are funcu.on „e lec . . bu' t hands ot.l„ npP"'"'1'·",--'"" t l>< cumprchensh-e

If b '"<!' "" " "" "'"

cad111· ng ciotro an active n. ose ind resource
. . . l t1ie ' "".".J time m<l
1·
J.Ob s,
. f 1 service. an . . .. " ,
1 US
 uncuons
contro , ..
resources directors ave, airectors
lisl
'
'"'"""'"'Uy p1wntll<'· 1tow th" <l<> th>'
•,111d U1'' t'inn. tlw. u ,1difüut-ll ti.l<·u'
r.n 11
0
h1 . d t h' wo• 1 . ,uni . 1 ' „
fdiffers '"'"'""s """'[, " uu thc• '
signiflcantlY aroun . lUI' " "rJs'
f
which stelll'
rrom .o . sc)Jara t1011 f<""'""
' .·11 . '"''"" ""'' the " "" "' '
e
„,
il "' ,, '"
1
. t h C scrv 11..c
1111
control functioO · vv c '