It seems intuitive to believe that the more independent a board is from the management of a company, the more inclined they will be to police the behavior of those managers rigorously. That was what emerged from a recent meta-analysis of 135 previous studies that was published recently.
The researchers highlight that board independence is commonly cited as a potential solution to the various instances of corporate misconduct that have made headlines in recent years. Indeed, in many countries board independence has been mandated in official rules. The picture is far from uniform around the world however.
The rationale is quite clear. An independent board is more likely to be a good board because they can act more impartially and dispassionately towards the company.
“Overall, independent directors, as compared to inside or affiliated directors, are expected to be more vigilant in their efforts to identify and snuff out corporate misconduct because, compared to inside or affiliated directors, they are more able to focus on the firm’s operational, financial and strategic irregularities and more motivated to monitor and curb misconduct to protect their personal reputations,” the researchers explain.
Is independence best?
The researchers wanted to test whether this assumption is actually correct however. They suggest there are various things that can prevent independent boards from being effective monitors.
They analyzed 135 different studies, which collectively examined around 80,000 companies over 20 different countries in what they believe is the first meta analysis done into the matter. First, they defined malpractice as an attempt by organizational members to deceive investors or other key stakeholders. This could, of course, involve breaking the law, but it could also include actions that are morally wrong.
In turn, independence was defined as when directors had no substantive relationship with the firm, either as employees or via any other capacity. The analysis revealed a number of variants of independence, including independent directors on the whole board, and on the audit committee.
The analysis revealed that generally speaking, an independent board was linked to lower levels of corporate misconduct. So too was a structure in which the CEO and chairman roles were distinct. The most influential ‘formation’ however was when the audit committee was independent, as their role in overseeing the financial and regulatory compliance of the company seemed to have the biggest role in policing malpractice.
Regional differences
Whilst this was generally speaking true around the world, the various rules and regulations in place around the world governing board behavior were important. If countries have few institutions to police corruption, then the optimum formations mentioned above had limited impact.
Equally, whilst board independence can easily be seen as a proxy for stronger company performance, the independence-misconduct relationship was roughly twice as big as the independence-performance relationship.
“Our findings on the influence of audit committee independence in reducing corporate misconduct offer an initial demonstration of the potentially wide-ranging influence of important board committees (such as audit, compensation or nominating committees) over firm behavior and performance,” the researchers explain.
The team believe that their findings could help to inform policy discussions to ensure that corporate malpractice is limited, and underline the importance of public institutions in working hand in hand with boards to prevent corruption.
