Board of Directors

Question 1

What type of duty does the BOD have to shareholders and the firm?

& meaning

Answer 1

Fiduciary duty

It ensures that directors prioritize the company’s well-being over their personal interests.

e.g.making careful and informed decisions, avoiding personal conflicts of interest, and acting honestly and transparently.

Question 2

What are some of the tasks of a BOD?

Answer 2

• Hire and fire senior executives
• Monitor senior executives’ performance
• Set executive pay
• Provide counsel on strategic decisions e.g. corporate restructuring

Question 3

Name four theories that motivate the existence of BOD and state name, date

Answer 3

1) Agency Theory (Jensen & Meckling 1976)

2) Resource Dependence Theory (Hillman, Cannella, & Paetzold, 2000; Pfeffer & Salancik, 1978)

3) Social Network Theory: (Granovetter, 1985)

4) Institutional Theory: (Scott 1995, DiMaggio & Powell 1983)

Question 4

What theory does Scott 1995, DiMaggio & Powell 1983 use that motivates the existence of the BOD?

Answer 4

institutional theory

Where boards of directors are motivated to exist and adopt specific structures by societal and institutional pressures for legitimacy, conformity, and isomorphism, with DiMaggio & Powell (1983) introducing isomorphism driven by coercive, mimetic, and normative pressures, and Scott (1995) expanding on these motivations through the three pillars of regulative, normative, and cultural-cognitive influences.”

Question 5

What theory does Granovetter,1985 use that motivates the existence of BOD?

Answer 5

Social Network Theory (Granovetter, 1985) which builds on the Resource Dependence Theory.

Firm’s economic actions are embedded in social networks, where embeddedness refers to the extent that economic actions are informed, influenced, and enabled by the network of accumulated stable and preferential social relations

e.g. boards effectiveness may be influenced by strength and nature of these wider social ties.

Question 6

Explain why the Board of Directors exists using agency theory

Answer 6

• Due to the Separation of ownership and control between owners and managers: need to ensure executives have value-maximising behaviour hence monitored by board.
• Incomplete contracts – makes it difficult to hold executives to account

Theory: Jensen and Meckling 1976

Question 7

Explain why the Board of Directors exists using resource dependence theory

& whose theory is this from?

Answer 7

The BOD exists because they provide 4 types of resources:

1) Advice and counsel – human capital (skills, expertise, knowledge)
2) Legitimacy – based on independence from senior executives

Networking:
3) Channels of communication between firm and external organisations
4) Assistance in obtaining resources from outside the firm

Theory: (Hillman, Cannella, & Paetzold, 2000; Pfeffer &
Salancik, 1978)

Question 8

Explain Executive Directors and their responsibilities

Answer 8

Contracted as Employees who are involved in the day-to-day operations of the firm and involved in major strategic decisions e.g. CEO/CFO.

Provide info to the board to facilitate NED.

Question 9

Explain non-executive directors and their responsibilities

Answer 9

They are not contracted as employees, they are contracted to provide services.

• Have no role in day-to-day operations
• Appoint and monitor senior executives
• Scrutinise major strategic decisions e.g. M&A, divestment
• Board is involved with finding suitable NED candidates, appointment approved by shareholder election.

Question 10

Explain how Board characteristics impact on Board effectiveness

Question 11

What are some board characteristics to take into account when evaluating a BOD?

Answer 11

• Size
• Independence
• Any outside directors
• Female directors
• Diversity

Question 12

How does NED’s impact the effectiveness of a BOD?

Answer 12

The more NEDs who are Independent then it leads to higher performance, Pearce & Zahra, 1991

because;
- Scrutinise executives who are biased to themselves
-They do not rely on the firm as their main source of income (in large FTSE PLCs they are paid about £78k)
- With no executive function, they can fulfil their duties independently.

Question 13

How does Board Independence impact the effectiveness of a BOD?

Answer 13

If the BOD is not independent enough then it will be biased towards the managements POV leading to a less effective BOD.

*NEDs need to be independent to fulfil their fiduciary duty to shareholders

Question 14

What leads to questionable NED’s independence?

Answer 14

Independence of NEDs questionable if….
- they are ‘affiliated outsiders’
- Boards are ‘interlocked’
- they are entrenched
- they rely on executives for information

Question 15

Name a study associated with Outside directors on the effectiveness of BOD

Answer 15

Pearce & Zahra, 1991: Larger percentage of outside directors associated with higher performance

Question 16

How does Size impact the effectiveness of a BOD?

(Pros/Cons to larger Boards)

Answer 16

For:
- More resources for monitoring/advice.
- More diverse expertise allowing members to specialise on committees
- Complex firms benefit from larger boards containing diverse expertise

Against:
- Larger boards suffer from slower decision-making. (More debates)
- Larger boards suffer from the ‘free-rider’ problem. (Benefits from privileges and prestige without actively contributing)

Question 17

Name studies associated with size on the effectiveness of a BOD

Answer 17

1) Dalton et al. (1999): Evidence of a positive board size–performance relationship

2) Coles et al., 2008: For “simple” firms performance decreases in board size, but for “complex” firms performance increases in board size

Question 18

How does Diversity impact the effectiveness of BOD?

Answer 18

For:
- Decisions are more likely to be challenged, overcoming Group-think hence better discussions.

Against:
- More difficult for decisions to be made due to less cohesiveness

Question 19

Name a study associated with Diversity and effectiveness on boards

Answer 19

Guest, 2019: No evidence of a relationship between ethnic diversity and performance

Question 20

Name a study associated with Female Directors on the effectiveness on BOD

Answer 20

Post and Byron (2015): Female board representation is positively associated with accounting returns but has no impact on stock market performance,

Question 21

How does female directors, ethnic diversity and NED’s impact on M&A activity/performance?

Answer 21

Female: Due to women being less overconfident than men, each additional female director is associated with 7.6% fewer bids, and each additional female director on a bidder board reduces the bid premium paid by 15.4%.” (Levi et al., 2014)

Ethnic diversity: No relationship between ethnic diversity and post-acquisition performance (Guest, 2019)

NED’s: Independent boards are more likely to resist takeover bids in order to get a higher price for shareholders (Cotter et al., 1997)

& Outside directors prior experience of acquisitions in the same product market has a positive effect on post-acquisition performance (McDonald et al., 2008)