Literature review: the role of the board – theoretical assumptions and empirical evidence
The board of directors is a key governance mechanism oriented at both monitoring powerful corporate actors and shaping strategy decisions with the final purpose to increase firm performance (i.e. Forbes and Miliken 1999; Hillman and Dalziel 2003; Kumar and Zattoni 2018). Board members are directly elected by shareholders and under corporate law, usually they represent the shareholders’ interests in the company (CHill and Jones 2001). Thus, the board can be held legally accountable for the company’s actions. Its strong position in the process of decision-making within the company allows the board to monitor corporate strategy decisions and ensure that they are consistent with shareholders’ or stakeholders’ interests - it depends on a board model.
Among the four countries (US, UK, Germany, and Japan) there are two board models: unitary and two-tiered. US, British, and Japanese boards of directors are the only boards required by law and are composed of a combination of executive and outside directors. This unitaiy board structure is typical of most public companies around the world with exception of Germany and certain central European countries, e. g. Austria and Poland. By law, German boards have two tiers, the management board (vorstauch) and the supervisory board (aufsichstrat). The management board’s membership and responsibilities are in many respects similar to those of US, British, and Japanese executive committees. The supervisory board is made up entirely of directors who cannot be members of the management board, half of whom are elected by the owners and half of whom are elected by employees (Lorsch 1997). Since the German and Polish supervisory board’s role is basically equivalent to that of US, British, and Japanese unitaiy boards, in further analysis we will be using the term board of directors only.
The typical board of directors comprises a mix of inside and outside directors. Formally directors are competent and reputed persons: successful managers, entrepreneurs, professionals, academics or politicians. In addition, directors receive a fee for their contribution and have fiduciary duties of loyalty and care to the company and its shareholders (Cyert et al. 2002). Highly involved boards tend to show initiative and are highly decisive - they provide advice when necessary and keep management alert. This means that the corporation is fundamentally governed by the board of directors overseeing top management, with the concurrence of the shareholder (Wheelen et al. 2018). According to B. Tricker, the main task of the board is to direct the company. This activity can be seen as a combination of four basic elements - strategy formulation and policy making, supervision of executive management, and accountability to shareholders and others. In fulfilling their duties, directors have to consider the future of the company as well as its present position and recent results, and also take a view looking inward at the company and its component parts as well as externally at the company in its competitive market context, and the broader economic, political, and social context in which it operates (Tricker 2009, 38). Of course, we have to remember that boards work with and act through management, working with and through their chief executive or managing director.
Institutionally, boards’ positions are really strong and they should act effectively. Despite this encouraging picture boards may fail to perform their duties. The first extensive research, conducted after World War II, pointed out that boards of directors were ineffective as a key governance control mechanism (Mace 1971; Mizruchi 1983; Lorsch and Maclver 1989). These early studies presented a discouraging picture: boards of directors tend to “rubber stamp” management proposals and may fail to perform their monitoring and strategy tasks. This happens because they had been dominated by managers. Managers not only control the selection process, but also establish remuneration policies for board members. There are many reasons for this situation. For example, some board members are strongly connected through family, personal or business relationships and hence may be unable to challenge powerful corporate actors. Moreover, directors can be tempted to approve inappropriate decisions promoted by executives or dominated by shareholders in order to be elected on the board. Furthermore, directors may not devote enough time to board duties (Kumar and Zattoni 2018).
The second stream of studies built an agency theoiy and developed the idea that a proper board composition and structure can increase board effectiveness in performing its monitoring and strategy tasks (Pearce and Zahra 1991; Johnson et al. 1996). Boards dominated by outside directors are more focused on the long- run maximisation of shareholder wealth and consequently, they press for innovation as a long-term corporate strategy. On the other hand, boards dominated by inside directors are more likely prefer risk reduction strategies, such as diversification strategies (Hill and Snell 1988).
The 1990s saw a growing role of institutional investors in corporations and increased pressure from investment and consulting specialists on boards to be more active. If in the previous decades their passiveness was tolerated, the last decade of the 20th century was a time of much higher expectations. It was suggested that their role could no longer be reduced to the monitoring or control functions alone, but that they should be more involved in strategic decision-making and, consequently, challenge the strategic leadership gained by managers.
In the mid-1990s, a thesis developed that more active involvement of the board is a necessary prerequisite for increased efficiency both of the board itself and of top management. A combination of a truly involved board and truly involved top executives ensures successful strategic management. Active boards not only increase their power inside corporations, but first and foremost, contribute to the improved quality of strategic decisions made by the company.
According to other experts, the following factors are crucial for the board’s effectiveness: the quality and comprehensiveness of information passed on by the company management, the size of the board (boards of more members are regarded as rather inefficient), frequency and regularity of the meetings held, and mutual trust and openness between the board and top executives. Rindova (1999) pointed out that in order to increase the benefits of the board’s participation in strategic management, its members should be active at all stages of the strategic decision-making process, such as environment scanning, interpreting and analysing the company situation and strategic choice. Forbes and Miliken (1999), added the need to treat the board as a “strategic decision-making group” and stress the cohesion requirement in the board’s operations, understood as the ability of board members to work as a team.
When discussing the board’s influence on a company’s strategic decisions, it has to be emphasised that the decisions in question are only those concerning the company as a whole. For in the strategic management process there is a clear distinction between corporate strategy and business strategy. Company strategy defines the scope of company activity, that is, the industries and markets where the corporation intends to compete. Thus, corporate strategy is a set of investment decisions including diversification, vertical integration, mergers and acquisitions, new ventures, as well as decisions pertaining to allocation of resources among the company’s various businesses and their potential liquidation. In contrast, business strategy defines the way in which a company competes in particular areas of its activity, that is, its chosen industries or markets. Since competition typically requires gaining competitive advantage over one’s rivals, business strategy is often referred to as competitive strategy.
The difference between company strategy and business strategy has yet another explanation: company strategy deals with the question of how a company intends to earn its money, meaning, what kind of business (industry) it should operate in. Business strategy, in turn, concerns the question of how management teams of particular businesses intend to build or maintain their competitive advantage.
Needless to say, company strategy is a permanent function and a fundamental choice of top executives and the board. Business strategy, however, is the responsibility of the management of particular businesses (divisional management).
As a body that approves - signs off on - a strategy, the board has to be aware of the special role that strategy plays in ensuring a company’s long-term effectiveness. Strategic thinking alone, based on adaptability and exploiting business opportunities as they arise, is not enough to achieve this goal. When analysing the proposed options, the board cannot overlook potential dangers posed by excessive optimism and aversion to risk, typical managerial qualities. For a manager’s own vested interest is not always in line with the best interest of the company (the principal-agent problem); on occasion, managers deliberately resort to distortions, half-truths, or even plain lies in order to force through their “only valid” proposals (Lovallo and Sibony 2006).
A question remains about the extent to which boards use the instruments of power at their disposal and why they are often regarded not as decision-making, but rather as decision-taking bodies. Strategic management specialists maintain that the role of the board of directors should be a critical assessment of draft strategic decisions proposed by top management and their official approval.
The picture which emerged from some empirical studies provides reasonable evidence that, e.g. British boards still are not directly involved in formulating company strategy, though they are not entirely passive in this respect, either. They are active in what Stiles calls a “strategic context,” which is creating a corporate vision and mission. Stiles argues that British boards primarily perform the role of a “gatekeeper” for managerial projects and strategic ventures. Other significant areas of British boards’ activity include ethical aspects of company operations: formulating and supervising the implementation of so-called codes of ethics and adequate internal value systems (Stiles 2001).
Studies conducted by Anderson, Melanson, and Maly (2007) yielded similar results. The researchers surveyed 658 directors, 14.6% of the total number of board members representing public companies based in Australia, Canada, New Zealand, and the United States. The vast majority of those questioned revealed that boards of directors were not treated as strategic assets in their respective countries, and that their knowledge and business experience were not sufficiently used. Still, the respondents did observe some positive, albeit slow, changes to this paradigm - an increased use of directors’ expertise in the process of formulating corporate strategies (Anderson et al. 2007).
The mixed results of the first and second stream experts do open “the black box” of board research in order to investigate board internal processes and dynamics. Board decision-making is strikingly episodic, with directors having very limited face-to-face interaction over a year (Minichilli et al. 2012) making it difficult to develop and reinforce the routines, norms and cuhure that typically characterise high performing groups (Pugliese et al. 2015). Consequently, practitioners and regulators have repeatedly pointed to the importance of establishing appropriate structures and processes to support board decision-making, e.g. annual calendars, board and coimnittee charters, decision making protocols, and behavioural ethical guidelines. These recommendations have included best practice guidance on how to process information organising (Bezemer et al. 2018).