Learning Mores and Board Evaluations

Posted by R. Christopher Small, Co-editor, HLS Forum on Corporate Governance and Financial Regulation, on Monday July 2, 2012 at 9:53 am
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Editor’s Note: The following post comes to us from Mijntje Lückerath-Rovers, Professor of Corporate Governance at Nyenrode Business University and Director of the Nyenrode Corporate Governance Institute in The Netherlands.

In the paper, Learning Mores and Board Evaluations – Soft Controls in Corporate Governance, which was recently made publicly available on SSRN, I argue that the prevailing boardroom mores, the unwritten rules, are at one end of having an impact on board effectiveness. Legislation, the more tangibly written rules, is at the other end. In between are voluntary codes of conduct, or legally embedded corporate governance codes.

How, without switching to increasing degrees of legislation with hard controls, do we provide direction to desirable conduct in the boardroom and thus to more effective corporate governance? International corporate governance codes were developed in the 1990s in response to declining trust in the financial system and exchange-listed companies. In recent decades, research into corporate governance focused mainly on the design of governance. Corporate governance codes were drawn up with guidelines for executive directors, non-executive directors and shareholders. The requirements in the corporate governance codes were aimed principally at establishing the conditions under which monitoring could be conducted, and less on the actual way in which this monitoring was conducted.

A shift is now also visible towards a more behavioural approach to corporate governance. It is, however. difficult to control behaviour because behaviour is integral to people and is difficult to measure or enforce. Nevertheless, politicians have taken the initiative of using legislation to enforce desirable conduct or to improve board effectiveness. For example, in The Netherlands (where the two-tier board model applies), this has led to a bill that maximizes the number of non-executive or supervisory positions one person may fulfil (5) and that requires a minimum percentage of both sexes, men and women, that should be appointed to both the executive and the supervisory board (30%).

Such legal requirements are aimed mainly at preconditions for being able to exercise good supervision (diverse composition, frequent attendance, commitment), and not for the way in which the supervision is actually conducted. This is due to the fact that it is easier to impose measurable, formal, generally-applicable conditions (hard controls) as opposed to requirements for desirable conduct (soft controls). But these are all simply indications, and the absence of these alerting indications is no guarantee that the undesirable situation will not occur.

My principal focus in this inaugural address is on the issue of whether, and how, non-executive directors can avoid further legislation. In other words, how can they take a closer look at their own mores and unwritten rules? The answer lies in the board evaluation. A formal and rigorous evaluation will bring to light whether 1) the highly desired open culture is present, 2) the individual non-executive directors are sufficiently dedicated, 3) the supervisory board and its members do indeed operate sufficiently, independently, and have a critical attitude towards each other and executive directors, and 4) the board is sufficiently diverse to prevent group thinking and tunnel vision. The evaluation needs to discuss these themes seriously and formally. In the end, when it comes to board effectiveness, mores may have more authority than legislation.

The full paper is available for download here.

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