RESEARCH PAPERS
Boards and Company Performance Research
Challenges the Conventional Wisdom
Lex Donaldson and James H. Davis
T here is a belief that companies would
perform better if their boards of directors
were to be made up of independent out-
siders, that is non-executives. Research to
date challenges that idea. The research re-
sults overall fail to find the expected superior
effects of having a board composed mostly of
non-executive outsiders who are indepen-
dent of executive management. There is even
some evidence that company performance
may benefit from boards of mostly executive
members.
Internationally there is a large, though by
no means conclusive, literature on corporate
governance. We shall attempt to highlight
a few salient points from the results of re-
search into corporate governance. The results
of this research tend not to support the idea
that a board of directors independent of man-
agement produces better outcomes for the
corporation. It provides no basis for prescrib-
ing that corporations must have a board
composed of mainly non-executive directors.
Moreover, there is some evidence that non-
executive boards produce worse outcomes
for their companies. Therefore we believe
that it would be unwise at the present time to
go along with calls to require boards of cor-
porations to be dominated by non-executives.
We would caution against this prescription -
pending decisive evidence that non-executive
dominated boards produce positive out-
comes.
The theory of the independent board
The dominant perspective is that boards of
directors should be independent of man-
agement (e.g. Jensen and Meckling, 1976;
Williamson, 1985; Kesner and Dalton, 1986).
0 Basil Blackwell Ltd. 1994. 108 Cowley Rd, Oxford OX4 1JF
and 238 Main St, Cambridge, MA 02142, USA.
151
-
To this end, the board should be composed
mainly of independent outsiders (i.e. non-
executives) and should have an independent
outsider (i.e. non-executive) as the chair-
person of the board. This prescription flows
from several premises. One is that boards
traditionally are supposed to have this func-
tion of directing management and represent-
ing outside owners, and that this is legally
expected (Tricker, 1984). A second premise
is that the board needs to safeguard the
interests of owners, especially outside
owners, against managers who will serve
their own interests at the expense of these
owners (Berle and Means, 1932; Williamson,
1985). This view is often called agency theory
and has become popular in academic circles
(Jensen and Meckling, 1976).A third premise
is that boards should represent all the stake-
holders: owners, employees, unions, women,
minorities, native people, consumers, sup-
pliers, government, community and so on
(Buchanan, 1958). All these views support
the necessity of an independent board. Thus,
there is much agreement among academics
and policy commentators in the community
about the proper function and shape of the
board.
However, many corporations have govern-
ance structures that depart substantially from
the ideal of the independent board e.g. they
actually have many directors who are execu-
tives or an executive as chair of the board. Thedominant
Kesner and Dalton (1986) document these perspective is that
breaches and argue that they lead to many boardsofdirectors
contemporary failings in the conduct of
corporations, because these corporations lack should be
an independent board that effectively con- independent of
trols management. Writing in the U.S. management
national context, they provocatively contrast
the constitutional checks and balances of the
Volume 2 Number 3 July 1994
152
U.S.government with the lack thereof in the
governance structures of many corporations:
What would happen if the President of the
U.S.were also Chief Justice of the Supreme
Court? And half the remaining justices
were members of the President's staff?
Our system of checks and balances would
obviously be dealt a death blow. But isn't
an analogous, unsettling scenario being
played out in some corporations? (Kesner
and Dalton, 1986: 17)
The question is whether the lack of an inde-
pendent board of directors in a corporation
produces the adverse outcomes presumed in
theory.
The research literature on boards contains
some studies which consist of asking direc-
tors for their views on the effectiveness of
boards. These studies are often seen as
unilluminating since they record socially
approved responses, platitudes and state-
ments of the conventional wisdom, and re-
main at the level of opinion. More useful are
those studies which examine the effects of
boards in terms of their outcomes, to see
whether they really have the general effects
claimed. It is these "hard data" studies which
will be drawn upon here.
Research of this sort into the outcomes of
boards has been conducted for at least thirty
years now (Vance, 1964). Guided by the re-
research has sought ceived theory, much of the research has
to show that boards sought to show that boards independent of
independent of management produce positive outcomes
such as higher profit and shareholder returns
management whereas boards dependent on management
produce positive produce negative outcomes. The research
outcomes results have been surprising, however.
The independent board and
corporate performance
Studies examine the composition of the direc-
tors and also whether the board chair is the
CEO or a non-executive. The empirical re-
search studies have failed to find any con-
sistent support for the proposition that
independent boards lead to better outcomes
such as greater profit or shareholder wealth.
Directors
Studies of directors have found mostly that
having boards mainly composed of executive
managers leads to superior economic per-
formance for the company and shareholders.
Having a board composed predominantly of
executives leads to higher corporate perform-
ance in the empirical study of Sullivan (1988)
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CORPORATE GOVERNANCE
and to higher performance on most indicators
in the study of Rechner and Dalton (1988).
Kesner (1987) also found that having a
higher proportion of insiders (i.e. executives)
on the board leads to higher return to in-
vestors in subsequent years and, for com-
panies in high growth industries, to higher
profitability in subsequent years. The use of
time-lagged data here lends support to the
idea that board structure is a cause of com-
pany performance. This study is particularly
interesting since Kesner is one of the most
trenchant academic critics of the executive-
dominated board (see above), but even her
study supports the executive-dominated
board.
A study by Chaganti et a1 (1985) found nil
effect of board outsiders on the probability of
the firm going bankrupt. Similarly, Pearce
(1983) found no relationship between board
outsiders and firm performance.
In the study by Pearce and Zahra (1992:
431) board outsiders has a positive effect on
subsequent company performance, but so
too does having more directors, whether out-
siders or insiders. This means that directors
of both inside and outside kind have a posi-
tive impact on company performance and so
the study fails to support the contention that
insiders have a negative impact. The study
findings should be coded as equivocal.
The point has been made that not all non-
executive directors are really independent of
executive management since some are tied to
the executives through being retired execu-
tives of the company or consultants or con-
tractors to the company or family connections
(Kesner and Dalton, 1986; Kosnik, 1987).
However, Pearce and Zahra (1992: 431) found
that the effect of such executive-affiliated
directors on company performance was
about the same as the effect of independent
directors. (Similarly, Cochran et a1 (1985: 670)
also found that distinguishing really inde-
pendent from pseudo-independent directors
had no effect on their results, as discussed
below.) Thus, distinguishing independent
from non-independent, non-executive direc-
tors does not affect the results.
Baysinger and Butler (1985) employed a
detailed system of categories to distinguish
between the various types of directors and
produced a tightly defined group of inde-
pendent directors. Having more such inde-
pendents on a board was shown to lead to
higher company performance ten years later.
Thus, their results provide support for the
role of outsiders in raising company perform-
ance. However, Vance (1978) also used a
system of detailed categories of different
types of directors and he also used a long
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 RESEARCH PAPERS
time-lag, yet found that insiders raised per-
formance and outsiders lowered it - the
opposite of Baysinger and Butler (1985).
Ezzamel and Watson (1993), in a study of
UK companies, found a positive relationship
between outsider, independent directors and
profit growth (after controlling for division-
alization of the management organization).
Since directors and profit growth appear to
be measured for the same time period there
may be some causation from profit to direc-
tors, nonetheless their study should be coded
as support for the independent board.
Thus, overall, there is limited evidence
from these studies that outsider, independent
(i.e. non-executive) directors raise company
performance and returns to share-holders.
Four studies found positive or mostly positive
relations between insiders and company per-
formance (Kesner, 1987; Rechner and Dalton,
1988; Sullivan, 1988; Vance, 1978), two
studies found nil effect (Chaganti et al, 1985;
Pearce, 1983), one study had equivocal find-
ings (Pearce and Zahra, 1992) and two
studies found a negative effect on company
performance (Baysinger and Butler, 1985;
Ezzamel and Watson, 1993). The proposition
that company performance is raised by
having more outsider (i.e. non-executive)
directors is not supported by this research
overall which rather calls into question the
supposed superiority of the outsider and
supposed inferiority of the insider.
Board chair
Studies of the board chair have produced
mixed findings about whether a non-executive
chair is superior to an executive chair, with
no consistent pattern overall. Two studies
show that having the board of directors
chaired by a person who is independent of
the executive management leads to higher
performance than when the board is chaired
by the top executive (Rechner and Dalton,
1991; Berg and Smith, 1978). However, the
findings of the first study hold only for ac-
counting measures of performance (Rechner
and Dalton, 1991), but not for stock market
measures of returns to shareholders (Rechner
and Dalton, 1989). The Berg and Smith (1978)
result suffers from inconsistency in the find-
ings as between the text and the tables (re-
porting a negative effect of an executive chair
in the text (Berg and Smith, 1978: 35) and a
positive effect in the table (Berg and Smith,
1978: Table A l ) ) . Thus, this study should be
coded as equivocal.
Donaldson and Davis (1991) show the op-
posite i.e. superior performance of boards
with executive chairs (though this is signifi-
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153
cant only for accounting measures). Chaganti
et a1 (1985) find a nil effect of the non-
executive chair on the probability of the firm
going bankrupt. Thus, overall, the findings
are mixed on the effect of an independent,
non-executive board chair on performance.
Molz (1988) has combined both the vari-
ables of the proportion of insider directors
and the executive chair, together with several
other aspects of board structure (e.g. number
of meetings, CEO tenure and minority groups
on board) that are mutually associated, into a
scale. Conceptually, this measures whether
the board is managerial or pluralist. Such a
multi-item scale would be expected to enjoy there is limited
greater reliability than the simpler measures, evidence from these
such as percentage insiders, that are usually studies that
used in research on boards, and so the results outsider,
should be more valid. However, Molz (1988) independent (i. e.
found no relationship between this scale and
company performance. non-execu t ive)
On both directors and chair, studies fail to directors raise
find consistent support for the superiority of company
the non-executives. Thus, there is at the performance and
present time no basis to assert the superiority returns to
of the non-executive oriented board. Hence
the widely shared assumption about the de- share- holders
sirability of a board mainly of non-executives
receives no overall support from the research
studies. Indeed the research studies call the
theory into question.
This is all the more remarkable given that
most researchers into boards have had as
their prior belief the notion that independent
boards are good (e.g. Kesner, 1987; Chaganti
et al, 1985). The failure of research to con-
sistently support the prior theory, and the
numerous contradictory findings, is remarked
upon by the reviews of this literature (Zahra
and Pearce, 1989).
Despite these results, agency theory has
continued to be a fertile source of ideas about
how managers in the large corporations
benefit themselves to the cost of the outside
owners (Jensen and Meckling, 1976).
The independent board and diversification
Whereas owners are held to want their com-
panies to accept risk - to gain returns -
managers are held to seek to minimise risks
for their corporation, preferring safe enjoy-
ment of their status (Baysingeret al, 1991; Hill
and Snell, 1988). This leads managers to
diversify the corporation, forsaking profit for
stability and larger size with consequent en-
hanced status and salary. Thus, the expec-
tation is that boards composed mainly of
executives will lead their corporations to
diversify. However, the empirical studies
Volume 2 iNumber 3 July 1994
154
show the opposite, namely that mainly non-
executive boards are more likely to have their
corporations diverse (Baysinger et al, 1991;
Hill and Snell, 1988). Thus, the agency theory
idea that managers propel their corporations
into ruinous diversification is not supported.
The independent board and R&D
agency theory Similarly, agency theory holds that managers
holds that are risk averse also in R&D. They will seek
to avoid the embarrassment of large R&D
managers are risk
projects turning out to be fruitless, and
averse also in R 6 D managers will therefore fail to spend on
R&D, leading to a dearth of innovation
(Baysinger et al, 1991; Hill and Snell, 1988).
A board mainly of non-executives will stop
this risk aversion, ensuring adequate corpor-
ate R&D. However, the two empirical studies
both find the opposite, that corporate R&D is
greater under a board mainly of executives
(Baysinger et al, 1991; Hill and Snell, 1988).
Again, the agency theory idea of risk aversion
is not borne out in reality.
The independent board and corporate illegality
Presently there is a concern about lapses in
corporate ethics and about corporations
breaking the law. Once again, a board mainly
composed of executives is seen as lacking the
objectivity to curb such corporate delin-
quency. The expectation is that a board
mainly of non-executives will resist breaches
in the law (Gautschi and Jones, 1987). How-
ever, of the two empirical studies, neither
offers any support for the idea that non-
executive directors or chairpersons of the
main board are more likely to keep the cor-
poration lawful (Gautschi and Jones, 1987;
Kesner et al, 1986). In fact, one study found
that the more outsider (i.e. non-executive)
board members, the more illegal acts by the
corporation (Gautschi and Jones, 1987).
The independent board and breach of
fiduciay responsibility
Boards that are executive dominated may be
perceived as more likely to fail to meet their
fiduciary responsibilitiesbecause of their lack
of independence from management. Kesner
and Johnson (1990) show that boards have
higher probability of being sued for failing to
maintain their fiduciary responsibilities the
greater the percentage of insiders and where
the board chair is also the CEO, that is, the
more executives dominate the board. How-
ever, executive dominated boards are no
more likely to be found guilty than non-
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CORPORATE GOVERNANCE
executive-oriented boards (Kesner and John-
son, 1990). Neither the percentage of insiders
nor having a dual CEO-chair was related to
success of the prosecution (Kesner and John-
son, 1990). It appears that executive domi-
nation increases the suspicion with which a
board is viewed but that there is no greater
level of actual guilt.
Conclusions on the independent board
Overall, the agency theory that non-executive
boards produce more positive outcomes is
not supported. These studies yield at least as
much support for the contrary proposition
that mainly executive boards are beneficial to
the corporation and its shareholders.
The independent board and takeovers
There is, however, one aspect on which the
agency theory literature has been more
successful to date. This is on the topic of
corporate takeovers. Agency theory holds
that corporate takeovers dislodge manage-
ments who are failing in their duty to share-
holders. Anything which blocks takeovers
therefore helps entrench unworthy manage-
ment. One such is where the corporation
resists a takeover bid by paying greenmail.
This buys off the raider but pays a high price
for the shares bought from him or her, thus
dispersing the wealth of the shareholder as
well as protecting incumbent management.
The expectation is that a board mainly of
managers will pay the greenmail whereas a
mainly non-executive board will not. A study
finds that executive oriented boards are more
likely to pay greenmail (Kosnik, 1987, 1990).
This supports agency theory.
While managers may resist takeovers, this
does not prove that managers are entrenched
to the detriment of the corporation and its
shareholders. Moreover, it assumes rather
than demonstrates the benefits of takeovers,
the value of which have been debated. Some
incumbent managers who have resisted take-
overs see raiders as destroyers of productive
assets and as saddling corporations with
ruinous levels of debt. Thus, the full meaning
of the takeover study has yet to be estab-
lished.
“Golden parachutes’’ are payments guaran-
teed to be paid to executives in the event that
their company is taken-over. Such payments
are seen as symptomatic of entrenched execu-
tives arranging a large consolation prize for
themselves in case a change of control jeopar-
dises their continuing consumption of cor-
porate perquisites. A non-executive domi-
nated board is held to be a safeguard for the
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 RESEARCH PAPERS
interest of shareholders that will resist adop-
tion of “golden parachutes”. Contrary to this
expectation, Cochran et al (1985) found that
golden parachutes were less likely to be
adopted the more insiders (i.e. executives)
were board directors. Thus, outsiders (i.e.
non-executives) on the board were not a
bulwark against the adoption of this benefit
for executives. Similar results have been
attained by Singh and Harianto (1989) giving
enhanced confidence to the finding of Coch-
ran et al (1985). Unlike greenmail, golden
parachute adoption is not forestalled by a
strong, independent board controlling man-
agement in the way agency theory postulates.
Other outsiders on the board
In contrast to agency theory, the stakeholder
model of boards argues that boards need to
contain not only managers and owners but
also other people who represent the com-
munity more widely. The implication is that
inclusion of these other people will lead to
many benefits, including, but not restricted
to, greater profit and shareholder wealth.
However, the inclusion of people who reflect
social issues had no effect on profit in two
studies (Vance, 1978; Molz, 1988). This re-
search on the stakeholder view seems not to
support the idea that including a wider set of
stakeholders raises profit. The results from
these studies must be regarded as tentative
and further research is desirable. There may
be other kinds of benefits, different from
profit, such as improving the way the corpor-
ation treats the kinds of people who are
normally excluded from the board, but this
requires further research to ascertain any
validity.
Reflections on the research into the effects
of board structures
Yet again we have been forced to record that
the research to date fails to support some
strongly held beliefs. The literature on boards
is unusual in the extent to which prior beliefs
and expectations from theory are challenged
rather than confirmed. It is possible that
there may be some deficiency in the method-
ologies of these studies, such as sample or
uncontrolled factors which is producing
anomalies. Certainly there is a need for more
research into boards to try to ascertain
whether there are problems underlying the
present findings. Yet these troublesome find-
ings crop up frequently and over many sub-
topics. It is rare for mere anomalies or quirks
to be so recurrent. Again, these strange find-
ings have been produced by many different
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155
people. Many researchers have gone in with
a commitment to the superiority of the out-
side, non-executive board. Since studies with
negative findings may be harder to publish,
the researchers have had incentive to per-
severe to identlfy method problems, etc., in
their studies and so eventually produce the
expected findings. As these uncomfortable
findings have existed in the published litera-
ture for about thirty years (from Vance, 1964
onwards), there has been time for their resol-
ution. Despite all this, many contrary find-
ings remain. Thus, the failure of thirty years
of research to support the prevailing theories
about the benefits of the “strong, indepen-
dent” board is striking, and suggests caution
in prescribing such boards as solutions to
problems.
The failure to find consistent, positive
effects of a non-executive dominated board
on company performance raises a disturbing
the stakeholder
question about the fundamental issue of model of boards
having a board at all. The whole idea of a argues that boards
board of directors is that a group of people need to contain not
called directors are needed to sit over on top only managers and
of the managers and direct the company. Yet owners but also
the expected positive benefit of having non-
executives as directors or as board chair has other people who
not been clearly supported by the research. represent the
Executive dominated boards often produce as community
good company performance as non-executive
dominated boards or sometimes better per-
formance. But even if non-executive domi-
nated boards lead to company performance
equal to executive dominated boards then
this is an uncomfortable fact. A board com-
posed of executives is really just a manage-
ment committee and a large company may
have many committees in which the man-
agers of the company meet. A board of direc-
tors only takes on a really distinct nature if
some of the directors are not executives and
so the board meeting is not just another
management meeting. Yet if non-executive
dominated boards perform no better than
executive dominated ones then the whole
rationale for having a board becomes suspect.
The company may just as well have a monthly
committee meeting of its senior managers.
Since the company may have one of these
already having a board composed of execu-
tives is just a duplication. Thus, there may be
no point in having a board of directors.
Abolishing the board would economise on
time and effort presently wasted by executive
management putting on the monthly ritual.
This at least is an issue that deserves further
investigation and discussion in the on-going
research and debate about boards. (One re-
search topic is whether executive dominated
boards that have a minority of non-executives
Volume 2 Number 3 July 1994
156
lead to better company performance than
boards solely of company executives.)
There are other functions that are claimed
to be made by a board of non-executive, out-
side directors, including legitimation of the
corporation (Parsons, 1961).This legitimating
function would be expected to contribute
positively to organizational performance and
so the studies reviewed herein overall cast
some doubt that the non-executive board
makes this contribution.
Some positive findings
From all this research, are there any signs of
how to build a more effective board? There
are some.
Chaganti et al (1985)found that the likeli-
hood of a company going bankrupt was
lower for companies with larger size boards
i.e. ten or more directors (whether executive
or non-executive). Again Pearce and Zahra
(1992)found that larger sized boards led to
greater subsequent performance. These two
findings both support the notion that boards
need to be of sufficient size to have wide
enough expertise. In the study of Pearce and
Zahra (1992), the effect of board size was a
little greater than the effect of outsiders on
company performance. This suggests that it
is the number of directors not their indepen-
dence from management that is the crucial
factor. This undermines the interpretation of
board size that it signifies a control role i.e.
strength through numbers for the directors to
check the CEO at the board meetings. Thus,
larger boards may promote company profit-
ability and perhaps also shareholder returns,
though further research is required. But any
such effect appears to be unrelated to the
supposed need for boards to provide an inde-
pendent control on management that is
asserted by both agency theorists and policy
reformers.
There may be some situations where the
non-executive board is superior and some
situations where the executive oriented board
is superior. This kind of idea is appealing to
academicians, and has worked in many other
topics in management theory. It is known as
the contingency approach and aims to ident-
~ factors upon which an effect of board
structure on performance is contingent.
Pfeffer (1972) identified three such con-
tingency factors that determine which board
structure is optimal: regulation, debt and
size. Corporations were more profitable if
Volume 2 Number 3 July 1994
CORPORATE GOVERNANCE
their board fitted these contingencies
(Pfeffer, 1972). The more regulated the
industry, the more outsiders the board
tended to have - to help the regulation, to
reassure regulators or to help the company
control the regulators (Pfeffer, 1972).And the
more the company fitted this pattern, the
better its profit. Also, there is a similar role
played by the factors of debt and size, though
weaker in magnitude. Companies with more
debt have more outsiders, including more
lawyers, and this is seen as helping obtain
debt financing (Pfeffer, 1972). Again, the
companies which fitted the pattern had better
profits, and this is interpreted as being a
result of the fit. Finally larger sized com-
panies had more outsiders on their boards.
And this is seen as reflecting their need to
reach out and control the society through
cooptation of diverse constituencies (Pfeffer,
1972). Again companies which fitted this
pattern had better profits. Thus, the optimal
effective board is created by fitting the design
of the board to the contingency factors of
regulation, debt and company size (Pfeffer,
1972).
The Pfeffer (1972)contingency model of the
board is based on the idea of boards as mech-
anisms to coopt external bodies on which the
corporation is dependent e.g. banks (see
Pfeffer and Salancik, 1978). These findings
lend no obvious support to the agency theory
of boards being needed to control managers.
(For a critical discussion of the cooptation
theory of boards see Donaldson, forthcoming).
A study of corporate illegality discovered
that corporations were less likely to break the
law if their executive committee (not the main
board) contained more outsiders (Gautschi
and Jones, 1987). This supports the view that
outsiders are needed to provide an indepen-
dent check on management. However, the
outsiders need to be on the executive com-
mittee. This body is more intimately involved
in the management of the corporation, and
may meet more frequently than the main
board. While the main board is superior in
authority to the executive committee, it lacks
the access to detail of the executive com-
mittee. This may argue that the main board,
by its remoteness and more part-time nature,
is a less effective means of controlling man-
agement than the executive committee which
is more involved with management.
Despite the positive results obtained in
these studies, there is apparently a dearth of
follow-up studies, so they remain uncon-
firmed and may be spurious. At the present
time it would be unfounded to prescribe from
these one-off studies. The findings remain
tantalising and deserve further research.
0Basil Blackwell Ltd. 1994
 RESEARCH PAPERS
Nationality of studies
Almost all of the findings quoted above are
for studies of U.S. corporations. There is a
need to conduct research in companies of
other nationalities to ascertain whether these
findings hold internationally.
Thus, we await the results of cross-national
research into the effects of boards. Nonethe-
less, the concerns about corporate govern-
ance are widely shared today in many coun-
tries around the world. This has produced
the body of U.S.research referred to above.
In deliberations in any country it seems
prudent to draw on the results of that re-
search, certainly until there is any evidence
that it fails to generalise to that country.
Inherent problems with board design
As we have seen, that research does not
encourage belief in the efficacy of the
"strong, independent board" as the cure
for recent ills. Why might this be? There are
two broad reasons why company profit and
shareholder returns may not be raised
through an independent, non-executive
dominated board: such a board may not be
able to check management or such a board
may not be required to check management.
We will consider each reason in turn.
Board unable to check management
In the U.S.the full board of directors meets
on average 7.3 times a year for 3 hours each
meeting (Bacon, 1993: 23, Tables 5 and 6).
Such full board meetings occupy 70 per cent
of the time that directors spend on board
duties on average (Bacon, 1993: 22, Table 3).
The other 30 per cent of the time is spent on
committees of the board (e.g. audit, nomi-
nating). Thus full board committees total
31 hours a year, on average; this is an average
of 2.6 hours a month. If, for the sake of esti-
mation, one adds to that an equal amount of
time for the director to read his or her board
papers and handle board business between
meetings, then this makes a total of about
five hours each month spent by the non-
executive director on their board meeting
activity. Such a small amount of time makes
it difficult for any outside, non-executive
director to be fully informed about the affairs
of a large, complex, fast-moving corporation.
The time problem alone makes it infeasible
that non-executives can control much better
informed executives.
Moreover, the independent, outsider lacks
a background in that company. Thus, the
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157
independent outside director is an amateur.
The executives are full-timers, frequently
with years of experience in that corporation.
These amateur outsiders face the near im-
possible task of controlling expert insiders.
Awareness of this deficiency has led to
suggestions that directors should give much
more time. In particular, it has been sug-
gested in Australia that the non-executive
chair of a large corporation should give three
days a week to that company i.e. 60 per cent
of the work week. If the directors worked
100 per cent for the company this would
undoubtedly solve the time problem, and
they would become expert in the company.
The problem is that they would have become
a new set of executives of the company.
Thus, the board would be composed of
executives and would have lost the outside,
independent quality. The interests of the
directors would have become those of man-
agement. Thus, there seems no way out of
the conundrum that outside, independent research does not
directors are part-timers who lack expertise,
whereas executive directors are full-timers encourage belief in
who lack independence. the efficacy of the
II
Perhaps the relationship between directors Strong,
and managers works because it is a harmoni- independent board"
ous collaboration. Well if it is, but what if
it is not? The issue posed in the present-day
climate is what happens if things are not right
and if management needs controlling? More-
over, managers may seek to conceal the truth
from outside directors. Outside directors
who sense that all may not be well will typi-
cally ask questions of the management at the
board meeting. However, management may
give replies which are less than fully truthful.
It is precisely an incompetent or devious
management which requires control. Yet
such a management will fob off the questions
from the outside directors. Thus, the non-
expert, outside board director is actually
unable to act effectively when needed i.e. to
apply control to a wayward management.
The non-executive board of directors is, by its
design, an ineffective control device.
Lately there seems some popularity to the
notion that the board can control the manage-
ment if given appropriate information which
identifies a few key parameters of corporate
performance related to its corporate strategy.
The prescription offered is to redesign the
information to the board. However, once
again the board depends on management in
practice to devise indicators and supply infor-
mation. Again, an incompetent management
may fail to have accurate, timely information
available.
Traditionally outside auditors are supposed
to help furnish the board with valid infor-
Volume 2 Number 3 July 1994
158
mation. Yet this can fail, and the spectre has
been raised of audit firms colluding with
incumbent management against the board.
Newspaper discussion of corporations select-
ing appropriate auditors has fuelled public
disquiet about the value and independence of
outside auditors.
Another contemporary prescription on
offer is that boards should focus on setting
strategy. This echoes earlier notions about
the role of the board to set policy leaving the
details of administration to management. But
again, devious, incompetent or careless man-
agement will not execute policy or strategy
satisfactorily. And it is difficult to separate
policy from administration, or strategy from
tactics and implementation. Strategy is not a
grand idea developed separately from prac-
tice. Sound strategy involves a knowledge of
strengths and weaknesses regarding the
company, its products, production processes,
personnel, customers, costs, prices and com-
petitors. This information comes from in-
volvement with the firm. The management
have this and the outside board do not. Thus,
it would be hazardous for outside directors to
insist on a policy or strategy independent of
the management. The more usual process
may be for outside directors to react to the
proposal of management and contribute
through discussion. This is fine if manage-
ment are sound. But if they are not, the
outsiders lack a basis to enforce an alternate
strategy which is valid.
A further, related suggestion is that there
should be professional directors. Such a
person is an outside director of, say, five
companies and gives each one day per week.
This improves the time allotted, from the
usual one day per month to one day per week,
but it is still much less than the full-time
management. Moreover, such professional
directors have surely been in existence in a
number of countries for many years without
obvious great benefit.
It has been further suggested that the lack
of information might be made good through
the professional director hiring one or two
assistants to help him or her keep track of his
or her companies. This might be an attractive
post for a bright young MBA graduate, before
moving on. This is a novel idea, however, we
again face the problem that examinations
from the outside rely on information about
the company which its managers choose to
make available.
A development of this idea might be to
have specialist corporate investigation firms.
They would field a team of various specialists
(law, accounting, management etc.) who
would work on an in-depth investigation for
Volume 2 Number 3 July 1994
CORPORATE GOVERNANCE
several months at the behest of the board.
They would be like consulting firms, but with
a more critical bent, and would serve the
board. However, in practice executive man-
agement might soon become their de facto
pay-masters, undermining their indepen-
dence. Such investigations are also costly, in
fees and in executive time and attention in
dealing with recurrent investigations.
Another solution offered to the conundrum
of the board is to have as outside directors
CEOs of other companies, who thereby bring
real experience. However, they lack knowl-
edge of the target company. Also academic
critics have argued that if managers in
general are wayward, then it is in the in-
terests of CEOs not to act aggressively on
outside boards, for fear of exciting the same
from their own board (Kesner and Dalton,
1986). Thus, cross-membership by CEOs is
seen as a sort of trade union of CEOs, which
once again compromises board independence.
Research shows that having executives from
other companies on the board tends to lower
effectiveness (Vance, 1978). If the board is to
free itself from dependence on its manage-
ment it may not completely achieve this by
becoming dependent on other managements.
The board of directors is supposed to direct
its company. The problem is that it is ex-
tremely difficult for such a body to direct.
This uncomfortable fact has been evident for
many years to many who have analysed the
board. Tricker (1984) tells us that the board of
directors was an invention in Britain in the
mid-nineteenth century at the time of the
creation of the joint stock company, to safe-
guard the outside shareholders from internal
management. It appears to be a device that
does not work to anything like the degree
envisaged.
A limitation of this present line of reason-
ing is that, while it explains why executive
dominated boards fail to produce higher per-
formance (i.e. because the boards cannot
provide an effective check on management),
it fails to explain why the executive domi-
nated board is sometimes observed to lead to
lower performance. The idea of the board as
an ineffectual check upon management
would be expected to lead to zero relation-
ship between executive domination and per-
formance. A negative relationship between
board executives and performance necessi-
tates a different theory for its explanation and
to this we now turn.
Board check on management not required
The alternate possibility is that boards may
not be required to check management be-
0 Basil Blackwell Ltd. 1994
 RESEARCH PAPERS
cause management is trustworthy and not
misappropriating the corporate profit and
shareholder wealth.
The theory that is the opposite to agency
theory is stezuurdship theory. In the area of
corporate governance, stewardship theory
argues that managers are good stewards of
the corporation and diligently work to attain
high levels of corporate profit and share-
holder returns (Donaldson, 1990; Donaldson
and Davis, 1991). Managers are principally
motivated by achievement and responsibility
needs (McClelland, 1961; Porter, 1964). Thus,
organizational financial performance and
shareholder wealth will be maximised by
empowering managers to exercise unencum-
bered authority and responsibility. Such an
arrangement most fully fits with their needs
thus maximising motivation. It also avoids
the role conflict and role ambiguity that arises
when authority and responsibility are unclear
or diluted. By having executives compose a
majority of the board of directors and by
having the chief executive chair the board
executives are empowered and motivated
(Donaldson, 1990; Donaldson and Davis,
1991).Thus, executive dominated boards will
lead to higher corporate performance and
shareholder returns.
Stewardship theory is supported both by
the results of studies of managerial moti-
vation (Argyris, 1964; Herzberg, 1966;
McClelland, 1961; Porter, 1964) and by the
research findings that greater corporate
performance results from executive domi-
nated boards (as reviewed above). Thus,
present empirical findings lend some support
to stewardship theory. This theory deserves
further consideration in future research.
Clearly, this is the opposite to the control
theories in agency theory and the policy
reform literature. The fact that stewardship
theory receives any support at all shows that
the control type theories need to be viewed
cautiously. These control theories should not
dominate thinking about boards to the ex-
clusion of other views. Indeed the possibility
exists that the control theories may be false
(for a critique of agency theory and allied
theories of organization see Donaldson,
forthcoming). Accordingly, the adoption of
non-executive dominated boards as a general
practice might have negative effects on
corporate profit and shareholder returns.
Conclusions
The research evidence on boards reviewed
here fails to support the widespread belief
that independent, non-executive boards pro-
0 Basil Blackwell Ltd. 1994
159
duce better outcomes for the corporation.
The studies of profit and shareholder wealth
fail to yield consistent evidence in favour of
non-executive dominated boards - with some
studies showing executive dominated boards
to be superior. Again, contrary to theory, stewardship theory
executive dominated boards are no more argues that
likely to lead to bankruptcy, to conglomerate managers are good
diversification, to under-investment in R&D,
to corporate illegality, or to failure of fiduciary stewards of the
responsibility. Thus, there is no basis to corporation and
prescribe that boards should be non-executive diligently work to
dominated. The part-time nature of the non- attain high levels of
executives makes it difficult for them to exer- corporate profit and
cise control over management where needed.
However, the nature of managers in general
share-holder
may be more benign than the presently returns
fashionable control-oriented theories war-
rant. Given the needs of managers for
responsible, self-directed work, organiz-
ations may be better served to free managers
from subservience to non-executive domi-
nated boards. Moves to impose non-executive
boards on companies in the belief that this
would thereby raise their performance are to
be viewed as courting danger.
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Lex Donaldson is Professor of Manage-
ment in the Australian Graduate School of
Management, in the University of New
South Wales. He holds a Ph.D. from the
University of London.
James H. Davis is an Assistant Professor in
the College of Business Administration,
University of Notre Dame, Indiana. He
holds a Ph.D. from the University of Iowa.
0 Basil Blackwell Ltd. 19