A Meeting of the School Trustees, Robert Harris, 1885 (Courtesy: National Gallery of Canada) 
Ideas for Leaders #506

Corporate Governance: The Power of Outside Directors on CEO-Only Boards

This is one of our free-to-access content pieces. To gain access to all Ideas for Leaders content please Log In Here or if you are not already a Subscriber then Subscribe Here.

Key Concept

Once packed with company insiders, corporate boards are filling up with outside directors, theoretically resulting in greater independent oversight. New research shows, however, that paradoxically having the CEO as the only insider on the board actually enhances the CEO’s power and undermines outside oversight.

Idea Summary

More and more board of directors have the CEO as the only insider on the board. At first glance, this movement toward near unanimous outside directors would seem to meet the mandate of independent oversight and governance that have defined corporate boards since the corporate scandals of the 1980s and 1990s.

In fact, new research — based on data for more than 200 companies covering the years 1981-2007 — reveals that the impact of reducing insider membership to only the CEO has the opposite effect. It reinforces the power of the CEO, and diminishes the power of the directors.

These CEOs build their power in various ways:

  • Gatekeeper of the information: When CEOs are the only insiders they become in essence the gatekeepers of all information that flows from the company to the board. CEOs are able to shape the information to correspond to their needs.
  • Building status: By being the only representative of the company on the board, CEOs have the opportunity to build up their status and power in a way that other insiders cannot. Already powerful by position, the gap of power between the CEO and the rest of the company becomes even more pronounced and intense.
  • Removing contenders. Having no relationship or exchange with potential heirs, the board is at the mercy of the CEO to shape the succession process to favour handpicked successors. In addition, CEOs ensure their own survival in the position, since the board has no information on other potential insiders who could replace the CEO.

The new research explored the conditions under which CEOs are more likely to successfully build a corporate board with themselves as the only insider representatives of the company.

First, researchers found that new CEOs who are faced with a larger number of company insiders on the board when they arrive are more likely to work to make the board CEO-only. Insiders who predate the arrival of the new CEO are much less likely to be allies ready to support the CEO, and may even be political contenders.

Second, the more power and influence CEOs gained, the more they pushed for CEO-only boards. ‘Dual’ CEOs, those that hold the positions of both CEO and Chairman of the Board, are the most powerful of CEOs. High stock-ownership, as well as a background in certain functions (notably finance, which gives CEOs an upper hand in controlling the company’s financial information) will also enhance the power of CEOs. The research, however, showed little correlation between these two levers of power and the likelihood of a CEO-only structure.

Third, environmental factors can impact the power of a CEO. CEOs with a finance background suddenly began working very hard to create CEO-only boards after passage of the Sarbanes-Oxley bill.

Finally, organizational contingencies such as the performance of the firm can also increase the CEO’s influence — especially when the origin of the power is either duality (holding the CEO and Chairman positions) or relatively high shareholdings.

Business Application

For many, the major debacles at companies such as Enron and Worldcom were caused by a lack of sufficient governance from boards of directors. This led to a push for more independent directors on the board, instead of inside directors.

It would seem that a board with only one insider, the CEO, is more likely to be independent. As the research shows, this is not the case. Quite the opposite. As a result, boards of directors should closely examine the current accountability and information-gathering dynamics at their firms. Are they receiving all information from the CEO? Do they have any direct contact with other members of the C-Suite that might be able to elaborate on the CEO’s information? Is there any succession planning in place, or has the CEO, instead, effectively put a lid on succession planning?

These are important governance questions for boards wishing to avoid the disasters that surprised boards of the past.

Contact Us

Authors

Institutions

Source

Idea conceived

  • December 2014

Idea posted

  • April 2015

DOI number

10.13007/506

Subject

Real Time Analytics