Boards of Directors: Seven Popular Myths

Boards Of Directors: Seven Popular Myths
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Seven Popular Myths Regarding Boards

Of Directors
By VW Staff on November 4, 2015 1:36 pm in Business
Seven Myths Of Boards Of Directors
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Series: Topics, Issues and Controversies in Corporate Governance No.

CGRP-51
Abstract:
Corporate governance experts pay considerable attention to issues
involving the board of directors. Because of the scope of the boards role
and the vast responsibilities that come with directorship, companies are
expected to adhere to common best practices in board structure,
composition, and procedures. While some of these practices contribute
to board effectiveness, others have been shown to have no or a negative
bearing on governance quality.
We review seven commonly accepted beliefs about boards of directors:
1. The chairman should be independent
2. Staggered boards are bad for shareholders
3. Directors that meet NYSE independence standards are independent
4. Interlocked directorships reduce governance quality
5. CEOs make the best directors
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6. Directors have signicant liability risk

7. The failure of a company is the boards fault
We ask:
Why isnt more attention paid to board processes rather than
structure?
Why arent more governance practices voluntary rather than
required?
Would exible standards lead to better solutions or more failures?
When do directors deserve the blame for a companys failure and
when is it the fault of management, the marketplace, or luck?
How can shareholders more effectively monitor board performance?
The Stanford Closer Look series is a collection of short case studies
through which we explore topics, issues, and controversies in corporate
CONTENT FROM OUR

PARTNERS
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governance and executive leadership. In each study, we take a targeted

look at a specic issue that is relevant to the current debate on
Jim Chanos Masterclass: The
governance and explain why it is so important. Larcker and Tayan are co-
Fundamental Short Seller
Fast Company
authors of the books Corporate Governance Matters and A Real Look at

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Real World Corporate Governance.

San
Seven Myths Of Boards Of Directors

Corporate governance experts pay considerable attention to issues
involving the board of directors. As the representatives of shareholders,
directors monitor all aspects of the organization (its strategy, capital
structure, risk, and performance), select top executives, and ensure that
managerial decisions and actions are in the interest of shareholders and
stakeholders. Because of the scope of their role and the vast
responsibility that comes with directorships, companies are expected to
adhere to common best practices in board structure, composition, and
procedure. Some of these practices are mandated by regulatory
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standards and stock exchange listing requirements; others are

advocated by experts, practitioners, and observers who may or may not
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Portfolio Strategy
have a stake in the outcome. While some common practices contribute
Based On
to board effectiveness, others have been shown to have no or a negative

bearing on governance quality. We review seven commonly accepted
Performance
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beliefs about boards of directors that are not substantiated by empirical

evidence.
Myth #1: The Chairman Should Always Be

Independent
One of the most widely held beliefs in corporate governance is that the
CEO of a company should not serve as its chairman. Over the last 10
years, companies in the S&P 500 Index received more than 300
shareholder-sponsored proxy proposals that would require a separation
of the two roles. Prominent corporations including Walt Disney,
JPMorgan, and Bank of America have been targeted by shareholder
groups to strip their CEOs of the chairman title. According to one
investor, No CEO, no matter how magical, should chair his own board.
Companies, in turn, have moved toward separating the roles. Only 53
percent of companies in the S&P 500 Index had a dual chairman/CEO in
2014, down from 71 percent in 2005. Similarly, the prevalence of a fully
independent chair increased from 9 percent to 28 percent over this
period (see Exhibit 1).
Despite the belief that an independent chair provides more vigilant
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oversight of the organization and management, the research evidence

does not support this conclusion. Boyd (1995) nds no statistical
relationship between the independence status of the chairman and
operating performance. Baliga, Moyer, and Rao (1996) nd no evidence
that a change in independence status (separation or combination)
impacts future operating performance. Dey, Engel, and Liu (2011) nd
that forced separation is detrimental to rm outcomes: Companies that
separate the roles due to investor pressure exhibit negative returns
around the announcement date and lower subsequent operating
performance. The evidence therefore suggests that the benetsand
costs of an independent chair likely depend on the situation. According
to Sheila Bair, former head of the Federal Deposit Insurance Corporation
(FDIC), Too much is made of separating these roles. Its really more
about the people and whether they are competent and setting the right
tone and culture.
Myth #2: Staggered Boards Are Always

Detrimental To Shareholders
Another widely held belief is that staggered boards harm shareholders
by insulating management from market pressure. Under a staggered (or
classied) board structure, directors are elected to three-year rather than
one-year terms, with one-third of the board standing for election each
year. Because a majority of the board cannot be replaced in a single year,
staggered boards are a formidable antitakeover protection (particularly
when coupled with a poison pill), and for this reason many governance
experts criticize their use. Over the last 10 years, the prevalence of
staggered boards has decreased, from 57 percent of companies in 2005
to 32 percent in 2014. The largest decline has occurred among large
capitalization stocks (see Exhibit 2).
While it is true that staggered boards can be detrimental to shareholders
in certain settings-such as when they prevent otherwise attractive
merger opportunities and entrench a poorly performing management-in
other settings they have been shown to improve corporate outcomes.
For example, staggered boards benet shareholders when they protect
long-term business commitments that would be disrupted by a hostile
takeover or when they insulate management from short-term pressure
thereby allowing a company to innovate, take risk, and develop
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proprietary technology that is not fully understood by the market. To this

end, Johnson, Karpoff, and Yi (2015) nd that staggered boards are more
prevalent among newly public companies if the company has one or
more large customers, is dependent on one or more key suppliers, or has
an important strategic alliance in place. They also nd that long-term
operating performance is positively related to the use of staggered
boards among these rms. Other studies also suggest that staggered
boards can benet companies by committing management to longer
investment horizons. Research evidence therefore does not support a
conclusion that a staggered board structure is uniformly negative for
shareholders.
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See full PDF below.
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Tags:
board of directors
classied board
corporate governance research

governance quality
independent director
director interlocks
indemnication
director liability
independence standards
Staggered Board
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Boards Of Directors: Seven Popular Myths

BREAKING NEWSNASA Expected To Make Huge Announcement About Mars

After A Four-Year Hiring Freez

Seven Popular Myths Regarding Boards

Seven Myths Of Boards Of Directors

1 Simple Way To Make

Stanford University Graduate School of Business

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Probiotic Supplement Melts Fat

September 30, 2015

Mom Loses 12lbs In 12

Rock Center for Corporate Governance at Stanford University Closer Look