A Political Meeting, Johann Velten, 1849 (Courtesy: The City Museum, Tier, Germany)
Ideas for Leaders #667

Why Boards of Directors Fail at Monitoring Their Companies

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Key Concept

New research reveals the 10 structural barriers, from board size to the complexity of a firm, that explains why boards of directors can fail to effectively monitor their companies.

Idea Summary

When a corporate scandal erupts, the same questions emerge: What was the board of directors doing? How could it let this happen? Why were directors not doing a better job of monitoring corporate management?

Failure in corporate governance is often attributed to board members’ incompetence or lack of incentive. After reviewing nearly 300 academic journal articles on board governance, a team of researchers from Texas A&M University, University of Illinois and ESADE Business School came to the conclusion that even competent, motivated board members face challenges in monitoring management because of a variety of structural barriers.

Successful monitoring, these researchers note, requires efficient and effective information processing — obtaining, processing and sharing information as individuals and as a group in the most productive way possible. However, 10 structural barriers impede boards of directors’ information processing capabilities, leading the board to fail in its monitoring duties. These barriers emerge from individual factors (related to the individual board members’ professional duties), group factors (related to the dynamics among the directors on the board), and firm factors (related to the characteristics of the boards’ firms).

One individual factor, for example, is outside job demands. As highly successful and very busy professionals, many board members simply do not have the time and availability to do their jobs effectively. Another individual factor is the complexity of outside job demands: with outside responsibilities involving complex issues and situations, the board member is unable to focus on the firm’s issues. Dissimilarity of outside job demands is another individual factor: a board member may not have the experience or knowledge required to make effective decisions for the firm.

Group factors include board size (large boards are less effective because of difficulty in coordinating actions, lack of cohesiveness, and other factors); meeting frequency (the boards meet too infrequently to build trust-based working relationships); diversity of the board (while diversity can add new perspectives, different backgrounds and experiences can hinder communication and assumptions about how to approach tasks); norms of deference (many board members follow social norms that call for deference to the CEO) and CEO power (powerful CEOs can control the agenda or board meetings — and who sits on the board).

The two problematic firm factors identified by the researchers are firm size and firm complexity. Firm size will lead to complexity (larger firms will likely have multiple products and multiple geographic markets), although complexity can also be increased through foreign ownership and other factors. In either case, part-time boards that meet infrequently do not have the time to fully understand the broad range of information technologies, products and markets of multi-product firms or the variety of cultural and regulatory environments of multi-geographic firms. How then can they monitor the activities and decisions of fully informed, full-time executives and managers?

Business Application

Board failures or difficulties in monitoring their companies are not due to lack of motivation or competence of the individuals on the boards. However, there are clear structural barriers that need to be addressed.

Since forewarned is forearmed, this research can help to make boards aware of structural barriers that might have been unnoticed, and respond accordingly. Notably, the specificity of the 10 barriers can help boards tailor their responses instead of seeking one-size-fits-all solutions.

To cite several examples: more frequent meetings — perhaps using information technology alternatives to reduce travel issues — and longer shared tenure to increase cohesiveness and trust on larger boards can help; norms of openness without fear of retribution could alleviate some issues such as social values that encourage deference to CEOs; and when function diversity — that is, boards with members completely unfamiliar with the issues and environment of the board’s industry — is a problem, strategic recruiting might help.

However, the researchers' suggestion, it may also be time to recognize what boards can do well — such as allocating resources and influencing key events (e.g., acquisition decisions) — and temper the expectations of a board’s monitoring capabilities.

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Authors

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Source

Idea conceived

  • January 2016

Idea posted

  • September 2017

DOI number

10.13007/667

Subject

Real Time Analytics