Government Should Regulate the Composition of Company Boards - Essay Example

Government Should Regulate the Composition of Company Boards Student’s Name Institution Course Date A company’s board is the primary unit used in analysing a business’ corporate governance. The board monitors, offers advice, reward and punish. Consequently, due to the diversity of the board roles, corporate boards are often comprised of individuals who have different skills and backgrounds. The number of directors that make up the board, structure of the board committee, percentage of directors from the outside, ownership positions of directors from the inside, and the total number of annual meetings characterize a corporates board composition. Over the years, a very minimum number of studies has focused on an exhaustive analysis of the relationship that exist between a board’s composition and corporate value (Carter, et al., 2003, p. 38). Following these diverse factors affecting a board’s composition, governments in recent years have started introducing regulations and disclosure-based approaches on corporates to help control a board’s composition. Consequently, these developments have led to a debate regarding the importance of a diverse board within an organization as opposed to one that is homogenous as well as the roles that governments should play to help regulate company boards’ composition (Packel, 2015, p. N.p). Nonetheless, despite the continued increase in board diversity within the last two decades, there still exists structural barriers within corporates boards that influence a corporation’s performance. Thus, governments should regulate the composition of company boards. Composition of Company Boards The composition of company boards is mainly concerned with issues that relates to the board’s independence or its diversity. i. Board Independence The concept of board independence is characterized by a corporate board whereby a significant part of its directors are independent and from outside the corporate. An independent board is perceived as more careful when it comes to monitoring a corporates managerial behaviour as well as its decision-making processes. The composition of a corporation’s board forms a fundamental basis of mechanisms used in corporate governance. It also impacts the degree as well as the effectiveness of the negotiating power of directors to mitigate agency issues and align the executive’s efforts in line with the interests of the shareholders (Altuwaijri & Kalyanaraman, 2016, p. 84). Board independence also greatly influences a corporation’s ability to effectively control and monitor the firm’s executive as well as mitigate agency problems. This is mainly because directors from the outside have no personal interests within the organization. As a result, independent boards made of directors from outside the organization deal with less agency issues and also enjoy enhanced links between management interests and those of the shareholders. Consequently, board independence is perceived as a way to enhance the performance of a firm (Pechersky, 2016, p. 84). Moreover, in corporate governance, board independence is vital because it allows external auditors to play their roles independent of their clients. In addition, internal auditors are also independent of their work colleagues during the auditing process. Non-executive directors, on the other hand, also are independent to a certain degree from the executive members on board. The concept of board independence emphasizes on the importance of acting in accordance with corporation’s policy and avoiding being wrongly influenced by individuals with stakes as well as avoiding any constraints that would hinder taking the appropriate course of action (Fuzi, et al., 2016, p. 462). ii. Board Diversity The idea that a corporate’s board should be comprised of directors outside the company has for a prolonged period of time been supported as the best approach to a corporate’s internal governance. However, there exists no consensus as to what comprises an independent board. Board diversity, on the other hand, refers to the percentage of women and other minority groups present on a corporate’s board of directors. According to Carter et al. (2003, p. 36), a board’s diversity is important because it helps a corporation to understand its marketplace based on demographic projections that help monitor the market’s diversity and matching it to that of the organization’s potential customers. It also increases suppliers’ ability to penetrate markets. A board’s diversity also increases the creativity and innovation of a corporate. Other attributes of a diverse board include effective skills to solve a corporation’s problems due to the heterogeneity of perspectives that offers the board with more alternatives to analyse and pick the best. In addition, board diversity also enhances the effectiveness of a corporate’s leadership (Carter, et al., 2003, p. 26). Diversity at the top of an organization’s management allows a wider view of things as opposed to the narrowed perspective evident in a homogenous management setting. Lastly, a diverse board is evidenced to promote global relationships that are more effective. Due to issues such as cultural sensitivity in organizations at a global level, ethno-culture diversity in multinational corporations make it possible for corporate leaders to become more sensitive to different cultures around the world. Some of the factors associated with board diversity include gender, age, and independence of the directors. According to Lamers (2016, p. 9) gender makes the greatest factor that is most evident in relation to board diversity. As a result, over the past few years, governments in different parts of the world have adopted different quota systems to help increase women representation in boards and other areas. An example where this approach has been adopted is in Sweden and France. Another example that shows the significance of gender in board diversity is when in 2002 the Norway coalition government made a threat that required organizations to have their boards comprise of 40 percent women if they failed to do so willingly (Kang, et al., 2007, p. 196). It has been evidenced that women presence in boards positively influences a corporation’s value. Women’s presence is advantageous because they have a sense of independence from the “old boys” system and they also have a well-versed understanding of customer needs, consumer behaviours, and existing opportunities for corporations to meet those needs (Lamers, 2016, p. 9). Age of directors is the other important element that influences a corporation’s board diversity. The most common characteristic observable in board members is that they are middle-aged, have good academic qualifications, are experienced, and mature. Conventionally, a large number of boards often comprises of “middle to retirement aged members” (Kang, et al., 2007, p. 196) who in the past have been executives in other companies but still in the same industry. However, with increased campaign for board diversity, a promotion for board members of different age groups is on the rise and aims at encouraging different perspectives for the corporation as a fundamental approach to succession planning. In this case, therefore, the older board members provide wisdom and experience on how to execute the corporate’s economic resources, the middle-aged group embark on major active responsibilities in the organization while the younger members provide the energy and drive desired for success. Lastly, board independence is the other factor that has continued to raise controversy with regard to board diversity. A corporation’s board independence from its internal management is paramount because it helps them to act in accordance to set rules and regulations as well as ensure that the corporation is acting in the interest of all people and not just the executives (Kang, et al., 2007, p. 202). To help ensure that the diverse board of directors are acting in the interest of all shareholders involved and not just their own, agency theory is used to propose the creation of a shareholders body to monitor the board’s activities. Therefore, the board of directors’ act as shareholders’ direct representation within corporations and their roles include monitoring and controlling to help protect the interests of all shareholders involved (Pechersky, 2016, p. 91). Board diversity is thus, based on the agent principle found in agency theory that emphasizes the separation of corporation ownership and management. Therefore, the board serves as an independent agent that oversees a company’s management for the shareholders. The board also works as a neutral ground for resolving existing conflicts between shareholders and the management through setting compensation as well as replacing management members who do not create any value to the shareholders (Carter, et al., 2003, p. 37). The agency theory favours board diversity because its views are based on the argument that board members from the outside have a low likelihood of colluding with board members from the inside to subvert the interests of the shareholders. Problems Over the years, corporations have developed to become powerful organizations. As a result, shareholders in these corporations encounter the challenge of being able to control their interests and also faces the threat of weakened accountability of the executive management. One instance where such a scenario is possible is where people on company boards particularly the chief executive officer (CEO) may use his or her position to influence the organization’s decision making and instead promote policies orchestrated to benefit his or her interests instead of those of the company. Consequently, this becomes a problem unless proper control measures and checks are put in place. Moreover, it is evidenced that 100 of the biggest multinational corporations control approximately 20 percent of world foreign assets. As a result, 51 percent of the largest global economies are made up of corporations while the remaining 49 percent is controlled by nation states. Consequently, this leads to the need for corporate governance. In 2011, for example, 63.4 percent, which was equivalent to 111 of the topmost 175 economic units as ranked in terms of GDP, were corporations (White, 2012, p. N.p). Among the highest ranking was the Royal Dutch Shell. This rise of modern corporations has led to an economic power concentration that competes at the same level with the modern state which can be related to as a struggle between economic power and political power where both are well grounded in their fields. On one hand, the state strives to find ways in which to control the corporation while on the other, the corporation with its gradual power increase strives to ensure that such regulations do not happen. In return, it is predicted that the current economic state of corporations may end up superseding the state and evolve to be the dominant aspect of social organization. Thus, it is important that governments regulate the composition of company boards. Other problems evident from issues of board composition include conflicts, insufficient communication and lack of cooperation among board members. The salient demographic nature of diverse boards has the potential to split the board into implicit subgroups. Consequently, demographic dissimilarity in the subgroups has the potential to limit communication among these board subgroups, which in return serve as a basis for conflict thereby minimizing interpersonal attraction as well as the cohesiveness of the members (Ferreira, 2010, p. 228). Board diversity also poses the threat of possible breakdown in communication between top management and directors from the outside who are the minority group. In a normal diverse board setting, outside directors have to rely on executive directors to get access to information specific to the corporation. In return, the top management may perceive the outside directors as sharing values that are different as well as espousing views that are dissimilar (Ferreira, 2010, p. 228). As a result, the reluctance of the top management to share important information with directors from the outside has the potential to compromise a corporation’s board effectiveness. The other problem is existence of conflicting interests between board members and agenda pushing. In a board’s composition, the intentions of some board members may be to push their own personal interests as opposed to that of the shareholders even at the expense of the firm’s profits. An example of such a scenario is the case of Enron where the company’s executives used their positions to advance their personal interests through fraudulence at the expense of the company. The problem further escalates in scenarios where the directors in a board represent agendas of outsiders. One example of such a situation is a board where directors have financial industry connections (Ferreira, 2010, p. 229). Compared to independent boards, diverse boards are tat a greater risk of unduly influence by board members who have varying personal as well as professional interests. Although the main reason for this issue is not really diversity, it occurs due to the misalignment of boards’ interests with those of the company’s shareholders. Lastly, the other problem evident in board composition is directors’ experience, inadequate qualifications, and overuse of existing directors as well as gender and racial gaps in representation. The existing model of choosing directors based on demographic traits leads to a neglect of other characteristics that are equally important. One example where the neglect is evident is in gender diversity in boards (Adams & Ferreira, 2009, p. 10). The proportion of women at the top executive positions in organizations is small compared to that of men. Additionally, due to the possibility of a short supply of qualified minority, there is a high chance that there will be disproportion in distribution of majority and minority directors within the board. Recommendations Although there has been progress in changing corporations’ board composition, companies are still struggling with internalizing diversity based on identity as a social norm. Consequently, if governments do not intervene in this situation, corporate inaction will keep on happening due to the combination of inherent cognitive partialities because existing networks of directors limit entry and are restrained in scope (Packel, 2015, p. 228). Therefore, the existing regulation provides firms with too much discretion that is not sufficient to help push for companies’ need to prioritize the importance of gender diversity in boards. As a result, the most important form of government intervention to help deal with gender and minority problem in diverse boards is use of disclosure as opposed to quotas. This method has been proven to be a success in the U.S. government because a disclosure regime that is invigorated is the most likely regulatory option that is viable (Packel, 2015, p. 229). Therefore, through government regulation, companies will be able to define diversity such that it includes all aspects often overlooked in board composition. These aspects include gender, race, and ethnicity. According to Dhir (2015, p. 230), the government should recommend for organizations to amend the disclosure rule or issue corporations with interpretive guidance that outline a particular definition that includes all minorities. If the government fails to provide organizations with a clearly spelt out definition of diversity, then the discloser considers itself freed of responsibilities and fails to take appropriate measures needed to address the existing problem of minority issues in board composition. The second recommendation is that governments should adopt a comply-or-explain strategy, which push corporations a bit harder as opposed to the existing disclosure models they are using. According to Dhir (2015, p. 254), governments should consider requiring corporations to comply with a set of rules or explain why they are not. These rules include adopting a diversity policy as well as disclose details to the minority, disclose the corporation’s current gender, ethnic, and racial composition of both nominees and directors, and establish internal objectives or adhere to government-set goals. The other rules are for corporations to conduct annual board assessments regarding the organization’s board diversity state and assigning culpability for execution as well as assessments of diversity policies (Dhir, 2015, p. 257). In applying these recommendations, governments will have an easy time regulating board compositions through ensuring that all board members are in compliance with their legal responsibilities. Additionally, the set rules will help ensure that directors act in good faith and are loyal to the interests of the corporations they oversee (Licht, 2012, p. 617). Conclusion There are two main concepts in board composition, which include board independence and board diversity. These two differ in that independent boards are grounded on the agency’s theory that emphasizes on the importance of separating corporation’s ownership with management. Diverse boards on the other hand are made of directors from both within the company (executives) and those from outside the company. Although both board composition have their merits, one significant problem that is evident is that with continued lack of government regulation, corporations are growing to become stronger than the existing political power and thus, there is the threat the in the near future corporations economic organism will be the new model where social structure is based. The other problem is that lack of government regulation may see continued increase in gender, race, and ethnicity gaps that exist in corporations’ boards. However, using the recommendations provided for by Dhir, governments can effectively regulate the composition of corporations’ boards. By helping deal with gender and minority problem in diverse boards using disclosure as opposed to quotas, governments can achieve this goal. The second strategy is for governments to adopt a comply-or-explain strategy, which push corporations a bit harder as opposed to the existing disclosure models they are using. References Adams, R. & Ferreira, D., 2009. Women in the boardroom and their impact on governance and performance. Journal of financial economics, 94(2), pp. 291-309. Altuwaijri, B. & Kalyanaraman, L., 2016. Is ‘Excess’ Board Independence Good for Firm Performance? An Empirical Investigation of Non-financial Listed Firms in Saudi Arabia. International Journal of Financial Research , 7(2), p. 83. Carter, D. A., Simkins, B. J. & Simpson, W. G., 2003. Corporate governance, board diversity, and firm value. Financial review, 38(1), pp. 33-53. Dhir, A. A., 2015. Challenging boardroom homogeneity: Corporate law, governance, and diversity. s.l.:Cambridge University Press. Ferreira, D., 2010. Board diversity (pp. 225-242). Oxford: John Wiley & Sons. Fuzi, S., Halim, S. & Julizaerma, M., 2016. Board Independence and Firm Performance. Procedia Economics and Finance, Volume 37, pp. 460-65. Kang, H., Cheng, M. & Gray, S. J., 2007. Corporate governance and board composition: Diversity and independence of Australian boards. Corporate Governance: An International Review, 15(2), pp. 194-207. Lamers, E., 2016. Board diversity and firm performance, s.l.: Radboud University. Licht, A. N., 2012. State intervention in corporate governance: National interest and board composition. Theoretical Inquiries in Law, 13(2), pp. 597-622. Packel, A. K., 2015. Government Intervention into Board Composition: Gender Quotas in Norway and Diversity Disclosures in the United States. Volume 192. Pechersky, A., 2016. Diversity in Board of Directors: Review of Diversity as a Factor to Enhance Board Performance. Studia Commercialia Bratislavensia, 9(33), pp. 88-101. White, D. S., 2012. The top 175 global economic entities, 2011. [Online] Available at: http://dstevenwhite.com/tag/worlds-largest-economic-entities/ [Accessed 4 July 2017]. Read More