A round-up of latest governance research

Friday, 13 May 2016


    US researchers examine the benefits of director overlap on board committees. A new report co-authored by INSEAD has 10 recommendations on becoming digitally savvy.

    In this month’s research round-up, US researchers examine the benefits of director overlap on board committees. A new report co-authored by INSEAD has 10 recommendations on becoming digitally savvy. UK academics make the case for boards to be custodians of the business model and McKinsey researchers consider why organisations are struggling with big-data analytics. Asia and German academics conclude the research round-up with a fascinating look at how CEOs protect themselves from being fired.

    Pushing the “pin”: benefits of cross-memberships on board committees

    Growing regulatory pressures worldwide have led to greater specialisations within boards and the rise of sub-committees, such as audit, remuneration and nomination.

    Typically, boards appoint a director to chair a sub-committee and put key directors on different committees. But is there greater value in having the same directors work across committees, such as audit and remuneration, and act as “linking pins” for the board?

    US academics examined the benefits of so-called “pin” directors in their paper, “I Know Something You Don’t Know!: The Role of Linking Pin Directors in Monitoring and Incentive Alignment,” published in the May 2016 issue of Strategic Management Journal.

    The authors, Pamela Brandes, Ravi Dharwadkar and Sanghyun Suh, considered the relationship of board-committee overlap (directors serving simultaneously on remuneration and audit committees) with CEO remuneration in US firms from 1998 to 2009. Their study controlled for factors, such as firm size, that are known to be associated with CEO pay.

    The research found that board-committee overlap is negatively associated with CEO pay, and positively associated with salary as a proportion of total compensation.

    Put simply, having directors who serve on the audit and remuneration committees provides greater intra-board information flows: the chairman of the audit committee, for example, can provide context about the organisation’s financial position for the chair of the remuneration committee. In theory, this can better align CEO pay with performance and improve the balance between short- and long-term incentives.

    The authors wrote: “A significant reduction in compensation can be achieved by enhancing information transfer processes on the board through the inexpensive use of linking-pin directors … clearly, board-committee overlap matters for level of compensation as well as pay mix.”

    The key message is for boards to think about the benefits of director overlap between committees, rather than automatically spread committee roles across directors. Finding other ways for directors to share knowledge across committees, beyond information transfers in the main board meeting, is another option for boards.

    10 ways to become digital savvy

    The phrase “digital disruption” has almost become a business cliché as executives and boards talk about the opportunities and threats of technology to their organisation’s business model.

    But there is still not enough hard evidence about how C-level executives and directors perceive digital technology, its uses, and how organisations expect to engage with digital in the future.

    Prominent Paris-based business school INSEAD has shed light on the concept of “digital” in a recent survey of 1,160 managers, executives and board directors across a range of industries and countries.

    The study, “The Real Impact of Digital as seen from the Virtual Coalface,” was released in late April. It provides important insights for directors who want to understand how their executive or non-executive peers view the role of digital technology within organisations.

    The study found there is no universal meaning of digital or one-size-fits-all way to approach it; that companies are not driven by digital but use it to achieve specific business objectives; that digital is a journey with no clear destination in sight; that not all companies need a digital strategy; and that digital success is primarily about people, not technology.

    The authors, Liri Andersson, founder of consultancy This Fluid World, and INSEAD Professor of Corporate Governance and Technology, Ludo Van der Heyden, wrote: “(Digital) success is perceived as rooted in leadership and management, yet a significant proportion of (survey) respondents feel this gets insufficient attention.”

    They found a disconnect between boards and digital changes underway in organisations and said board awareness of digital transformative initiatives was low.

    The authors wrote: “Not only must board members stay abreast of these developments, they need to be made aware that digital is a fundamental disrupter and that one digital solution does not fit all. A digital transformation has an effect on the entire organisation and is inextricably linked to its future success. A disconnect from digital is a disconnect from business, and thus undermines the board’s competence in the governance sphere.”

    The authors listed 10 recommendations for organisations with digital:

    1. Clarify and qualify what you mean by digital
    2. Own your digital journey
    3. Make digital everyone’s business
    4. Fully explore the opportunities digital offers before defining a solution
    5. Be wary of “expert bias” in the digital space
    6. Engage the entire board in digital
    7. Make people, management and culture the main drivers of digital
    8. Measure the effect of digital on business success
    9. Decide if you need a standalone digital strategy
    10. Manage the spill-over effects of digital on the wider organisation

    Boards as custodians of business models

    Business models are receiving more governance focus as the global move towards integrated financial reporting encourages organisations to explain how their latest profit relates to the organisation’s value drivers and strategy in a more streamlined way.

    But is outlining a simplified view of an organisation’s business model in the annual report enough? Can stronger custodianship at board level – where directors are responsible for developing and sustaining the business model – lead to more effective governance?

    UK academics Michael Page and Laura Spira considered this issue in “Corporate Governance as Custodianship of the Business Model”. The paper was published online in the Journal of Management and Governance in the first quarter of 2016.

    The intersection of business models and boards is a fascinating governance topic. In most organisations, the executive team develops and owns the business model.

    High-performing boards coach executives on strategy, and shape and oversee business plans as part of their strategic governance role. But few boards, it seems, own the core business model at the heart of strategic decisions, or make enough governance decisions through a business-model perspective.

    The authors argue that viewing governance decisions through a stronger business-model lens can highlight aspects of the board’s role that have not been clearly articulated in corporate governance frameworks.

    They wrote: “For a board of directors, corporate governance and sustaining and developing the company’s business model are essentially the same thing. This is because the two systems entail the same goals and the same activities by the board.

    “Viewing corporate governance through a business-model lens offers a fresh perspective on the role of the board that provides improved integration between its strategic and compliance responsibilities. This can potentially enable a better understanding of how corporate governance contributes to the achievement of corporate objectives, rather than acting as a constraint.”

    Boards and big data

    Big data is an increasingly important topic for boards. The ability to capture, analyse and harness large quantities of data – at executive and board level – could be a key differentiator between high- and low-performing organisations in the next 5-10 years.

    Boards that govern for performance need to know the organisation’s CEO is capable of sponsoring or leading big-data projects; that the executive team has sufficient analytics capabilities; and that there is broader organisational capability to incorporate big data into decision making.

    Increasingly, boards will ask if directors have the right skills to govern organisations that rely on big data, and if they, too, can harness analytics to improve governance decisions.

    However, new McKinsey Institute research shows organisations are having mixed success in meeting their analytics objectives. The paper, “The Need to Lead in Data and Analytics”, was published in the May 2016 edition of McKinsey research highlights.

    The problem is not lack of analytics tools or strategy. Rather, it is a lack of analytics leadership, support and communication, ill-fitting organisational structures, and challenges in finding and keeping the right people in analytics, says McKinsey.

    Much is at stake: 86 per cent of executives surveyed said their organisation had been at best only somewhat effective in meeting their analytics objectives. A quarter said they had been ineffective, according to McKinsey’s survey of 519 executives across a range of industries.

    High-performing companies said their analytics activities had a greater effect on revenue in the past three years, compared with low-performing companies, found McKinsey.

    Executives in high-performing companies ranked senior-management involvement as the main factor for their analytics success. Those in low-performing companies said their biggest challenge was designing the right organisational structure to support analytics. The high-performers benefit from strong CEO support for analytics activities.

    McKinsey wrote: “On the whole, responses suggest company leaders are less involved in analytics efforts than they are in digital activities … even when analytics is top of mind for company leaders, many of them don’t seem to be communicating a clear vision throughout their organisation.” About a third of CEOs said they led their company’s analytics agenda, but most C-level executives saw analytics as the chief information officer’s role.

    McKinsey suggests three ways companies can improve their analytics capabilities. First, communicate the importance of big data to staff from the top. “Company leaders must continually articulate the importance of analytics by hosting town-hall meetings, monitoring results on company dashboards, and incentivising senior managers to focus on these initiatives.”

    Second, organise for success. “However they decide to organise, though, companies must ensure they have the right balance of technical and domain expertise, that resources are being used efficiently, and that all analytics resources align closely with the goals and targets of the business units they support.”

    Third, find new ways to attract talent. McKinsey wrote: “To attract good people, companies will need to develop a distinct culture, career paths, and recruiting strategy for data and analytics talent; ensure analytics employees have a close connection with company leaders; and articulate the unique contributions data and analytics talent can make.”

    These suggestions are a useful guide for boards to frame discussions with executive teams on how they are building their organisation’s big-data capabilities.

    How CEOs save their job

    The concept of “managerial discretion” is receiving more consideration in governance literature. Researchers are trying to understand if CEOs exploit an information imbalance between executive teams and directors for financial or reputational gain.

    United States and Korean researchers have examined whether CEOs exercise managerial discretion to avoid being fired. This could include cutting research-and-development spending or other expenses to boost earnings, meet financial targets, and placate investors.

    The paper by Sungsoo Kim, Rakesh Sambharya and Jong Sun Yung, “Do CEOs Exercise Manager Discretion to Save Their Jobs?”, was published in the March 2016 issue of the Journal of Management & Governance. The research examined 474 US firms that had a CEO turnover event during 1992-98.

    The researchers hypothesised that compared with CEOs in non-turnover firms (no CEO change), CEOs in turnover firms cut discretionary spending to boost reported earnings during the period preceding their termination. They might slash short-term spending to boost earnings per share and potentially save their job, even though there could be long-term consequences.

    The authors wrote: “The findings of this study suggest that CEOs facing termination exercise managerial discretion by decreasing expenses to boost earnings and to show better financial performance. Clearly, a significant difference exists between turnover and non-turnover firms, especially after a CEO-succession event, proving the attempts of showing better performance by cutting discretionary expenses.”

    The authors argue that boards need to strengthen their oversight powers and demand explanations from CEOs (about decisions to cut expenses) if it is possible they could be asked to resign. They say complacent boards can “rubberstamp” CEO decisions to cut costs, believing it will smooth earnings and satisfy the investment community, even though the move might be about saving the CEO’s job.

    They wrote: “The power of CEOs increases with tenure, thus the temptation to retain their jobs is rather understandable. However, due to the asymmetry in the power dynamics, minimal oversight is practised over the discretion exercised by CEOs. This manifests as a major problem in corporate governance.”

    Can social status prevent a CEO from being fired?

    Two CEOs lead underperforming companies. They have similar tenure and the market is equally disappointed in their results. The first CEO keeps his job; the second is dismissed.

    There are, of course, many reasons why a board chooses to retain one CEO and ask another to resign. Directors might argue that the CEO deserves a second chance, that there is no obvious successor, or that factors beyond the CEO’s control hampered performance.

    But could a CEO’s social status in business also explain his or her survival? In this hypothetical example, the first CEO who keeps his job is well known and connected in governance circles through directorships. The second CEO worked his way up into the job, has never been on other boards, and has a lower profile in the governance community.

    German academics have analysed the role social status plays in CEO dismissals – an intriguing topic for directors. No board task is more important that choosing the right CEO, incentivising that person, monitoring performance, and asking him or her to resign if needed.

    Their paper, “How CEOs Protect Themselves Against Dismissal: A Social Status Perspective”, was published in the latest edition of the Strategic Management Journal.

    Researchers from the Munich School of Management and the School of Business and Economics at Freie Universität Berlin analysed CEO dismissals in large publicly listed German firms over 2002-11. They identified 45 CEO resignations from 119 CEO departures that appeared to be dismissals rather than planned CEO succession events.

    They determined social status by capturing the number of outside directorships held by the firm’s CEO relative to board seats held by the organisation’s chairman. In doing so, the researchers could determine if the dismissed CEO was part of the “corporate elite”.

    The researchers found that an underperforming CEO with a high social status in business compared with the chairman was less likely to be dismissed. The authors wrote: “High-status chairmen of boards are an important factor for effective corporate governance decisions – and especially the dismissal of a poorly performing CEO.”

    In other words, organisations led by CEOs with high business status need chairmen who have similarly high status. A reputational imbalance between the board and CEO can make it harder to dismiss an underperforming CEO.

    The researchers acknowledged the limitations of their study; namely, the challenges in identifying CEO dismissals, measuring CEO social status in business, and the unique characteristics of two-tier German supervisory boards.

    But their work is an important contribution to governance literature. Its main takeout is the need for boards to consider the CEO’s status in business when appointing directors and the chairman. “Generally speaking, high-status CEOs should face a high-status chairman to achieve a balance of power at the top,” the authors wrote.

    Having genuine diversity of boards, with at least some directors who are not part of the corporate elite, and thus less influenced by the CEO’s social status in business, can also lead to more effective governance decisions around CEO dismissals.

    Latest news

    This is of of your complimentary pieces of content

    This is exclusive content.

    You have reached your limit for guest contents. The content you are trying to access is exclusive for AICD members. Please become a member for unlimited access.