Good directions: What makes a board effective?

Academic interest in how corporations are governed has grown since the WorldCom and Enron Corporation scandals of the early 2000s and the global financial crisis of 2008. Researchers want to understand why things go wrong in corporate boardrooms and what measures might alleviate or avoid future problems.

Do boards of directors composed entirely of white men behave differently when women and minorities are appointed? How does the personality of a CEO affect the chief executive’s relationships with directors? Why did firms with female leaders perform better than companies with male chief executives during the recent recession? These are among the questions researchers at the W. P. Carey School of Business have been studying. The business school has become a leader in corporate governance research, producing important studies on the composition of boards, CEO characteristics, executive compensation and interactions among key players in the corporate world.

“The research in corporate governance is very broad, and it crosses disciplines,” said Associate Professor of Management David Zhu, an expert in social and psychological aspects of management. “If there is a common theme at the W. P. Carey School, it would be interactions between CEOs and boards of directors and how they affect corporations. Researchers approach it from different perspectives.” Academic interest in how corporations are governed has grown since the WorldCom and Enron Corporation scandals of the early 2000s and the global financial crisis of 2008. Researchers want to understand why things go wrong in corporate boardrooms and what measures might alleviate or avoid future problems.

Diversifying boards

Zhu and his coauthors — Associate Professor of Management Wei Shen and Professor of Management Amy Hillman — recently published the results of an extensive study of how boards behave when demographically different directors are appointed. The researchers found that when more women and minorities became directors, boards are more independent of CEOs and more likely to curtail CEO pay.

The researchers also discovered that female and minority directors are more likely to make their presence felt on boards if the new members share attributes of existing board members. For example, a woman joining an all-male board would be more likely to have influence if she had attended the same college as an incumbent director. Shen has been examining the roles that company insiders and outsiders play on boards.

In recent years, activists and investors have pressed for more outsider appointments to encourage boards to be more independent of CEOs. But simply appointing more outside directors does not guarantee board independence, according to Shen. “The reason is that independent directors do not have very much in-depth, firm-specific information,” he said. “If the only insider is the CEO, then the other directors have to rely heavily on the CEO for their information about the firm.” Boards that have a balance of insiders and outsiders tend to be the most independent, according to Shen.

The best board for an IPO

Professor and Management Department Chair S. Trevis Certo has conducted studies on aspects of corporate governance. “What I’ve typically been interested in is the interface between investors on one hand and executives and boards on the other,” he said. Certo has studied the effects that characteristics of boards of directors have on initial public offerings. He found that IPO underpricing — which owners of a company going public want to avoid — is less likely to occur if boards of a company are larger or have members who have positive professional reputations. Steve Hillegeist, associate professor of accounting, studies what happens to boards of directors when firms purchase liability insurance for members. “We found that when a firm has too much coverage, it can cause problems for corporate governance,” Hillegeist said. “These firms have a higher risk of litigation and their auditors charge them higher fees.”

Associate Management Professors Christine Shropshire, Suzanne Peterson and Peggy Lee (along with their co-authors Emily Amanatullah from the University of Texas-Austin and Erika Hayes James at Emory University), have been exploring how gender differences in risk-taking affect CEO decisions. Their research builds on prior studies that suggest that in the Great Recession, firms with female leadership outperformed other companies.

Scholars have speculated that female-led companies did better because women are less likely than men to take risks. But after surveying CEOs and studying the performance of firms, the W. P. Carey researchers found the explanation to be more complicated. Female leaders were not always more riskaverse than males, but women were less likely to take risks during economic downturns, the researchers concluded. They discovered that women tend to be more “other-oriented” than men, approaching managerial decisions with greater focus on the interests of the company and its stakeholders, and that economic recession accentuates this trait and its effect on risk-taking.

When CEOs think highly of themselves

Zhu has been studying how CEO personalities affect their companies and their relationships with boards of directors. In one study, he looked at how a CEO’s narcissism affects corporate decision-making. A CEO who is highly narcissistic will be unlikely to accept input from directors, Zhu found. “In many situations, the narcissistic CEO would actually do the opposite of what the experience of fellow board of directors would suggest,” Zhu said.

Zhu conducted his research with Guoli Chen of the international business school INSEAD. To measure CEO narcissism they developed a scale that used several criteria, including how large the CEO’s photo was in a firm’s annual report, how many times the CEO’s name was mentioned in press releases and the pay gap between the CEO and other executives in the company. In another study, Zhu and Chen found that narcissistic CEOs tended to select directors who were similarly narcissistic and that these directors were more likely to support excessive risk-taking by CEOs. “When CEOs select individuals who appreciate their narcissism, the executives are encouraged to take even higher levels of risk,” Zhu said.

Assistant Professor of Management Mathias Arrfelt also studies how CEO behavior affects firm performance. One focus of his research is how companies allocate — or misallocate — capital. “Current performance in relation to expected performance seems to drive allocations. Corporate decision-makers allocate too much capital to business units that are performing below aspirations and have relatively worse prospects for future performance, and not enough capital to business units that are performing above aspirations and have relatively better prospects.” Arrfelt said. He compares corporate decision-makers to investors who often add to positions in underperforming stocks while taking profit on better performing ones. “In some sense, you are throwing good money after bad,” he said.

First published in the autumn 2015 issue of the W. P. Carey magazine.