Corporate Governance: Assessment of the Determinants of the Effectiveness of the Board.

By Mutui

1. INTRODUCTION

1.1 Background

There has been significant interest in corporate governance since mid-1980 both in the practice
and academic world. This has been brought about by the unearthing of major global business
scandals such as Lehman Brothers, WorldCom, and Enron Corporation had global impacts
(Ogbechie, 2012). As such, corporate governance issues have been brought into scrutiny as each
bout of scandal comes with a fresh round of discussion on the role and effectiveness of
governance systems. For instance, the WorldCom and Enron scandals brought issues on the
independence of the board and the role of auditors and audit committees while issues of insider
trading were the key focus of the 1990s Asian financial crisis. At the core of discussions in the
failure of Lehman Brothers were remunerations for the executive. In all these cases, the concern
has been all about the structure of corporate governance and particularly the role and
effectiveness of the Board of Directors.

Consequently, there have been a lot of theories and investigations into the role of the
effectiveness of the board concerning corporate governance. Similarly, there exist ambiguity as
to whether the effectiveness of the board is positively related to the performance of the firm. This
is because it is not easy to gauge the extent to which the board contributes to the performance of
the business. However, it is easier to measure whether the board acted effectively if, for instance,
it was able to avert a disaster such as a retreat to turn around a failing industry and reverse
defective decisions by the CEO. At times, such actions are rarely noticed in the outside world,
thus making it a daunting task in assessing the effectiveness of the board. This implies that the
effectiveness of the board is interpreted within the context of the working relationships of
directors in discharging their roles.

In many of these corporate failures in the last couple of decades, the question that lingers in the
minds of scholars, practitioners, and policymakers alike is where was the board (Nordberg &
Booth, 2018).) and how effective was the board? This leads to another question of what it takes
to measure the effectiveness of the board to the extent that such meaning of effectiveness has the
same understanding among the directors themselves, scholars, policymakers, and practitioners.
In regard, scholars have opined that it is not easy to identify conditions making up effectiveness
and as such this matter elicits a lot of debate from a policy and practical perspective (Nordberg &
Booth, 2018). This has called for some actions especially in developed countries such as the
USA to instate measures of enhancing board effectiveness such as periodical reviews of board
performance Cadbury (1999). Other regions such as the United Kingdom (UK) have followed
the suit (FRC,2018) with the enactment of policies demanding assessment of the board
performance be undertaken by external facilitators to enhance objectivity. This trend has gained
traction and has been adopted in many other counties in different environments for the public
listed companies (OECD, 2015).

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Given the worrying trends of erosion of corporate governance as witnessed by increasing entities
that were once described as too big to fail, several proposals have been put forth in an attempt to
restore corporate governance and rebuild public trust (Ogbechie, 2012). In some studies, the
emphasis on corporate governance is on the working and composition of the board (Van den
Berghe and Levrau, 2004). Within the African context, corporate governance is viewed from the
financial performance and board characteristics (Ujunwa, 2012). However, Baptista & de Melo
(2010) argues that besides structural factors influencing the effectiveness of the board, there are
non-structured factors that influence the effectiveness and strategic decisions of the board. These
are behavioral, cognitive, social, and environmental factors. In this regard it is yet clear which
factors act as the determinants of the effectiveness of the board, hence the need for the study.

1.2 Theoretical Framework of Evaluating Board Effectiveness

Both structural and non-structural factors are believed to influence the performance of the board.
To accommodate varying views on board evaluation and effectiveness, Forbes and Milliken
(1999) developed a model which integrates all the factors that are perceived to influence the
performance of the firm as influenced by the effectiveness of the board. This model is illustrated
as here-below.

Figure 1: Theoretical Framework

1.3 Problem Statement

Studies have shown that identification and measurement of the effectiveness of the board is a
complex issue (Allen et al., 2004). It is also argued the performance of the firm may be
influenced by the effectiveness of the board. According to Forbes and Milliken (1999), the
board’s performance of its task may be used to assess its effectiveness. This effectiveness is
depicted by the execution of its tasks of control and service effectively.
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According to Baptista & de Melo (2010), the functions of the board can be grouped into four
tasks, namely; strategy, service, resource provision, and monitoring. The framework of agency
theory supports the monitoring task that entails the protection of shareholder wealth and risk
management (Fama and Jensen, 1983). The stewardship theory supports the service task
(Donaldson and Davis, 1991) which supports and advises the management. The activities of
strategic direction and management implementation of the strategic plan are with the board’s
task of strategy (Phan, 1998). On resource provision tasks, the board is responsible for the
provision of resources, maintaining the relationship with stakeholders, and ensuring legitimacy
and experience are forestalled in the firm (Ong and Wan, 2008).

The extant literature presents the effectiveness of the board as either structural or non-structural
structural dimensions. Included in the structural dimensions are feature such as the size of the
board, the CEO duality, experience, and independence of the board to mention a few. Although
extensively researched, there still exists uncertainty as to the relationship between firm
performance and the structural characteristics of the board. This is partly because studies have
shown that non-structural factors restrain direct relations among directors. According to Forbes
and Milliken (1999), such non-structural factors could be behavioral, cognitive, power
dimensions, and work processes.

But more recent models of the effectiveness of the board, complementary approaches have been
employed incorporating both structural and non-structural views. In this regard, Ong and Wan
(2008) grouped the models into process and mediation categories of which the former explains
the effectiveness of the board from a structural standpoint. The mediation models are holistic to
the extent that they combine both structural and non-structural factors on assumption that there is
an interrelationship between the structure of the board, processes, and the performance of the
firm.

Despite these varying dimensions and factors, the ensuring discourse fails to demonstrate the key
drivers of the board’s effectiveness. This study sought to establish the determinants of the
effectiveness of the board.

2. LITERATURE REVIEW

This section provides reviews of the extant literature on the determinants of the effectiveness of
the board from theoretical and empirical perspectives.

2.1 Theoretical Literature Review

Several theories have been put forth to explain the relationship between effectiveness and
performance. Three theories were explored in this paper, agency theory, stewardship theory, and
stakeholders’ theory.

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2.1.1 Agency Theory

This theory argues that the principals lose control of the agents as the firm grows in size. Hence
the agents effectively seize control over the principals leaving them at the advantage of pursuing
their vested interests at the expense of the principals (Mizruchi, 1983).

According to this theory, the effectiveness of the board is important for the continuity of the firm
and more so when there is a clear distinction between the roles of the executive and the board
(Fama and Jensen, 1983). This effectiveness will depend on how the board and executive
discharge their duties in the protection of the shareholders’ interests.

On the flip side, this theory fails to address the organizational life complexities, hence prompting
the need to assess other theories about the effectiveness of the board.

2.1.2 Stewardship Theory

This theory advocates that the managers should perceive themselves as stewards who work in the
best interest of the principals (Donaldson and Davis, 1991). In this theory, the motivation of the
steward should be aligned with the overall goals of the organization such the attainment of those
goals will benefit all the stakeholders and business.

In contrast with Agency theory, the theory advocates for the CEO’s duality such that there is no
loss of control as the CEO who is the steward is also the chair of the board (Ju and Zhao, 2009).
This theory has been criticized for its advocacy duality role which is frowned upon in the modern
governance world.

2.1.3 Stakeholder Theory

According to the Stakeholder Theory, the key focus is to balance the conflicting interests of the
various stakeholders. These stakeholders may include stockholders, managers, workers, and
suppliers. In this theory, the interest of the board is in performance to ensure it meets the
expectations of the stakeholders. To actualize such expectations, the board is required to have the
right mix of directors in terms of experience and background for its effective functioning. The
theory has been propagated by the proponents of the balancing of human and social capital in
corporate governance.

However, the theory falls short of certain expectations as observed by Freeman & McVea
(2001). who argued that the theory failed to offer guidance in ranking or reconciling competing
interests. Also, It does not stipulate how the effectiveness of the business will be judged.

2.2 Empirical Literature Review

Several approaches have been used to determine the effectiveness of the board (Van den Berghe
& Levrau, 2004). According to Nicholson & Newton (2010). effectiveness is measured by the
extent to which tasks and outcomes fulfill the set goals. However, the role of the board is not
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always very clear and, in some instances, the role of the board could be multiplicative while in
other cases it could be contradictory (Hung, 1998). According to Baptista & de Melo (2010), the
functions of the board can be grouped into four tasks, namely; strategy, service, resource
provision, and monitoring. However, in the case of Zahra & Pearce (1989), there are three roles
of the board, namely strategic, control, and service. In other studies, the role of control is the
same as oversight or monitoring while the service role is likened to the advisory role. These roles
as discussed hereunder.

2.2.1 Control Role

In the control role, the board put in place control mechanisms to ensure the actions of the
management are in line with the interests of the owners. This entails mechanisms for selecting
and recruitment as well as removal from the office of underperforming CEO and management,
establishing incentives for the management, and monitoring and evaluating the performance of
the organization (Zahra & Pearce, 1989). The emphasis of this role is to ensure the management
work in the best interests of the shareholders by having in place control mechanisms for the
action of the management (Hillman & Dalziel, 2003).

2.2.2 Service Role

This is probably one of the key functions of the board. In this role, the board provides the CEO
and management with expert counsel and accessibility to resources that are within the reach of
the directors. The role is derived from both resource dependence theory and stewardship theory.
In the case of the resource dependence theory, the board is responsible for linking the firm with
external organizations that are related to its functions (Pfeffer and Salancik, 1978).

From the stewardship theory, there is the affirmation of legitimacy for strategic engagement. As
such, there is mismanagement of corporate resources since there are other nonfinancial
incentives for managers such as the derivation of satisfaction from successful performance and
recognition. In the absence of management vested interests, the question is what drives the
managers to high performance (Muth and Donaldson, 1998).

2.2.3 Strategic Role

This role of the board entails the formulation and execution of strategies for the success of the
firm (Watson, 2002; Useem, 2003). There has been increased interest in this role as directors are
going from the traditional role of monitoring to strategic roles that adds value to the firm
performance (Leblanc and Gillies,2005)

2.3 Board Characteristics and Processes

The ongoing discussion on the role of the board to enhance the effectiveness of the board
through improved performance. The effectiveness of the board is a result of resources and
activities of the board, input, and processes all directed toward the role of the board. For the
board to be effective, certain structural and non-structural dimensions factors influence the
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performance of the board. As we look into the characteristics of the directors, board, and the
process in the analysis that follows:

Characteristics of the individual directors: These are the demographic characteristics of

knowledge and skills possessed by individual directors. They are easy to know by obtaining
one’s career details. Board interlocks studies have shown that it may be possible to assess the
social capital of an individual director from the outside world. However, it may not be possible
to know the social capital of individual directors on the board, thus leading to board cohesiveness
and cognitive conflict and rendering external assessment of interpersonal relations irrelevant
within the board context.

Similarly, Charas (2015) argues that the use of data sources may not say much about one’s
persuasiveness, thought processes, and sensitivity to cultural variations whether through either
peer-to-peer evaluations or the use of internal evaluators such as the chairman. Thus, a better
way to assess individual characteristics will be to use external evaluation and ethnographic
approaches as suggested by Nicholson et al. (2017).

Board characteristics: According to Forbes and Milliken (1999), these are demographics that
the board collectively possesses. They could be a mix of professional backgrounds, gender, and
ages. They show diversity on the board which is a solution to excessive cohesiveness. However,
existing empirical studies do not clearly show such diversity affects the tasks of the board and
the performance of the firm (Homberg & Bui, 2013). As with individual characteristics, it is
possible to assess the board characteristics since background information about directors, and
structures of the board are now becoming publicly available. There is an increasing need to
improve board diversity, thus the focus is on assessing how such collective characteristics affect
the processes, effectiveness, and evaluation processes of the board.

Board processes: The board processes are hard to observe especially where there are no clear
policy prescriptions. While processes such as attendance of board meetings may be easily
available, certain features such as how the board uses their skills and knowledge may not be
visible. Similarly, cognitive conflict is not possible and only manifests itself when there is the
collapse of board cohesiveness.

More often, there a several reasons for hiding information on board processes. While
confidentiality (Zhang, 2010) could be one of the reasons, other factors such as political forces
greatly affect director persuasiveness, emotional intelligence, cultural behavior, and social
capital all of which have an impact on board processes and effectiveness.

3. METHODOLOGY

According to Daily et. al., (2003) majority of studies on boards of directors and their
effectiveness have used quantitative data analysis techniques. In this many studies, archival data
and questionnaires are used for data collection. In some studies, mixed-method design
encompassing both quantitative and qualitative methods have been used (Teddlie and

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Tashakkori, 2003). In the case of Creswell et. al. (2003), a two-phased methodology entailed
collecting qualitative data after which quantitative techniques were used for data analysis.

In this study, a review of existing literature was relied upon to determine key determinants of the
effectiveness of the board. The study used Google Scholar to search for relevant articles and
journals containing keyword searches such as board effectiveness, board of directors, corporate
governance, and structural and non-structural dimensions of the board.

4. FINDINGS AND DISCUSSIONS

This section provides a discussion of the results of the key findings from the literate review on
the determinants of the effectiveness of the board. From the analysis of the existing literature, it
is clear that the effectiveness of the board affected the performance of the board. Board
performance refers to how well the board executes its roles of control, service, and strategic and
working mechanisms with the management for the larger good of better performance of the
organization. Analysis of the various studies reveals interesting results of determinants of the
effectiveness of the board as discussed here below.

There was a positive and significant relationship between the decision-making and the
effectiveness of the board. This means that the quality of the board’s decisions has a direct effect
on its roles of control, service, and strategic functions. According to Zona and Zattoni (2007),
the quality of the decisions made by the board is influenced by factors such as cognitive conflict
and open discussions which in turn affect its effectiveness.

Another factor that had a positive and significant influence on the effectiveness of the board was
board cohesiveness, implying that the higher the level of cohesiveness the more effective the
board was in executing its roles effectively. This cohesiveness is exhibited by the presence of
strong teamwork. According to Kemp (2010), teamwork enhances board effectiveness and
processes as 90% of the respondents in the study mentioned. It was observed that the working of
the boards involved complex decisions and teamwork by way of collective decisions,
information, and resource sharing was critical for the effective functioning of the board
(Hambrick, 2007). On the contrary, less cohesive boards could work at the mercy of powerful
CEO and were ineffective in rendering strategic advice to the top management.

The operations of the board positively influenced the effectiveness of the board. This means that
processes of good operations enabled the board to perform its duties effectively. Good operations
were demonstrated by timely and quality board reports, well-defined responsibilities of follow-
up of pending matters, the proper understanding of the roles and responsibilities of the board,
and the conduct of the board meetings.

However, analysis of the various studies revealed that the size of the had no significant
relationship with the board’s operations, cohesiveness, and decision-making, hence the size of
the board failed to demonstrate any effect on the board’s effectiveness. Studies by Randoy and
Jenssen (2004) attest to this finding and that the size of the board had a significant influence on

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the performance of the firm. However, studies by Bozec (2005) and Guest (2008) assert that the
size of the board had a significant and positive influence on the firm’s performance.

On CEO duality and independence of the board, studies have failed to demonstrate how they
affect the processes of the board, thus they do not influence the effectiveness of the board. Based
on the accounting parameters, Randoy and Jenssen (2004) established that the independence of
the board had no impact on the performance of the board. Similar findings were reported by
Bhagat and Black (2002) as they did not establish how the independence of the board contributed
to the better performance of the firm. These findings as well as those of Wintoki et al. (2009) and
Coles et. Al (2008) observe that the size and independence of the board have no relationship to
the performance of the firm. According to these studies, the formation of the board is depended
on the contract environment and their information.

Owing to rising corporate scandals, there has been a clamor to separate the role of the CEO and
the Board chairman all over the world (Wilson, 2008) as there is more effective monitoring when
the chairman of the board is independent of the firms’ operations. Equally the same is for the
CEO who is not the chair of the board as he can focus on the daily operations of the firm while
providing support to the board. However, this argument of CEO duality is still inconclusive as
there is no sufficient evidence linking the relationship between board processes and CEO duality
to the roles of the board. But Hwang and Kim (2010) have countered this argument of
independence noting while the board may appear independent on paper, their dalliance and
personal connection with the CEO outside the office could render them less effective in
monitoring the firm performance.

The was a significant and positive relationship between job-related diversity and the
cohesiveness, operations, and decision-making of the board, thus better decisions for a more
diverse board. Diversity, in this case, means different experiences that can be relied upon for the
enrichment of board operations. This positive relationship is attributable to the fact there is a
tendency for creativity and innovation and quality decisions emanating from a more diverse
board (Bilimoria and Wheeler, 2000) which leads to sound planning and decision making. It has
been established that there is a high likelihood of strong cohesiveness when the board is diverse
contrary to the belief that of possible discordances due to varying views and opinions. However,
there are cases where diversity has been reported to have a negative impact such as failure to
reach a consensus on strategic decisions (Knight et al., 1999).

The presence and use of board skills, knowledge, and experience otherwise known as
professional human capital were found to positively and significantly influence the decision-
making and cohesiveness of the board, thus indirectly but positively affecting the effectiveness
of the board. This human capital is important to support management as well as participation in
key strategic actions and decisions that are bound to benefit from such specialized knowledge
and competencies possessed by a diverse board. Hence, the greater the human capital of the
board the better the effectiveness of the board and firm performance (Stewart,1997).

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5. CONCLUSION

While the importance of corporate governance has been growing in an attempt to enhance board
effectiveness, there is no consensus on the key determinants of effectiveness and it will vary
from one situation to another. There have been assumptions in many studies that the
effectiveness of the board is determined by its independence and structure of the board. This is
not the case as this study has established that various factors influence performance and they
could be processes and demographic factors that contribute to the board’s effective performance.
As such the study has demonstrated that good performance of the board is a result of cooperation
and quality decisions arising from quality information.

Contrary to many expectations that structural dimensions such as board demography are key
determinants of board effectiveness, this study has established that the determinants of board
effectiveness are actually from non-structural dimensions. These are, for instance, board
processes and decisions, cognitive conflict and open discussions, cohesiveness, board operations,
job-related diversity, and presence and use of board skills, knowledge, and experience.
In conclusion, there is a need for further research to incorporate non-structural factors into the
performance and evaluation of the board’s effectiveness as they have shown to significantly and
positively determine the performance of the board.

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