Governance and Sustainability - Assignment Example

GOVERNANCE AND SUSTAINABILITY Name Institution Affiliation Course + Code Lecturer Date Introduction Corporate governance and accountability has in the past few years generated a lot of research attention with many researchers choosing to examine the mechanisms through which corporate management can improve governance and accountability. Given the significance of the management in enhancing governance and accountability, there has been a corresponding emphasis on the need to have a management team that can improve governance and performance of organizations. It is this renewed interest in management that saw many organizations adopt a hierarchical management and decision-making structure with a team at the apex of the hierarchy, the Board of Directors (BOD). This paper seeks to undertake a critical analysis of the role played by the BODs in ensuring enhanced governance and accountability in organizations based on the outcomes of empirical studies and further investigate the impact of governance aspects such as board diversity on corporate accountability. Moreover, the fundamental concepts of corporate governance will be discussed to comprehend the deficiencies that exist in corporate governance systems. Background to the Use of BODs in Corporate Governance To comprehend the role that BODs play in corporate management today, it is important to investigate the conditions and factors that led to the adoption of the boards as the ultimate bodies of decision-making in organizations. Most empirical literature materials trace the origin of using BODs in corporate management to the conditions brought about by the growth in financial markets. In essence, it is espoused that before the advent and growth of the stock market, large companies were managed by the owners, and there was a need to incorporate more people into management for such businesses to expand. Using BODs in corporate management was necessitated by the need for economies (economies of scale) to grow that required a large number of different investors to provide money for companies that created an aspect of limited liability in which the team of investors (Board of Directors) made ultimate decisions concerning the management of the business (Solomon, 2007, p. 3). In this respect, therefore, the board of directors acted as the owners of the business and made decisions pertinent to the fact that the outcomes of such decisions would influence their profitability and by extension, business performance. Empirical studies have also provided political motivations as having driven the corporate world to adopt the use of BODs in top organizational management. For instance, corporate scandals such as that of Enron led to the need to have a body of directors that needed to take political responsibility for a flaw in corporate management (Chevron, 2016, n.p). Moreover, the growth of companies led to a need for a managerial best practice that would facilitate efficient business decision-making as “group decision-making commonly replaces the solitary decision-maker” (Gevurtz, 2004, p. 94). In some regions of the world, there was a need to have in place a board of directors as a necessity for compliance in order to run organizations, and the legitimate boards would be accountable to the state on behalf of the organization (Gevurtz, 2004, p. 94). Nonetheless, BODs became necessary to provide diversity in the management of organizations by pooling together experienced professionals with diverse inputs into the organizational management system (Adams et al., 2008, p. 4). Therefore, empirical studies show that the use of the Board of Directors in organizational management was necessitated by the need to have an effective decision-making system, have a body that would bear political responsibility for the operations of the company and provide representation for shareholders who had invested their money in the organization as a means of protecting their interests in the organization. Moreover, the need to have a diversified approach to the management of business operations necessitated organizations to pool together individuals with varying inputs that could improve the management of organizations. Nonetheless, the adoption of BODs was in some instances necessitated by statutory provisions in certain jurisdictions. Significance of Board Diversity and Role of BODs in Corporate Governance Board diversity refers to the representation of diverse perspectives, professionals and experience in the management team that makes for a board of directors. Board diversity is crucial because it provides for an integrative approach to decision-making and solving of organizational problems. There have been some radical definitions of the term as it is used in the corporate platform, for instance, Walt & Ingley (2003) posits, “diversity is an expression of the broadening of the merit principle rather than an argument for representation” (p. 219). According to Russell (2016), a wide range of perspectives and not just token representations are very effective for organizational management because board diversity enables the board of directors to navigate complex and dynamic issues in the corporate world. More aptly, it has been ascertained that in deliberating the possible outcomes of a decision in board meetings, obtaining diverse views of the impacts of the likely outcomes improves organizational management by taking into account the perceived risks, implications and consequences of board decisions. Russell (2016) observed that diversity is particularly crucial for the management of corporates because the contemporary challenges faced by organizations “are too hard for any one person to figure out.” The implication of this outcome is that there are problems that cannot be solved by a single individual or rather a single school of thought; therefore, necessitates for a deliberate construction of a diverse team of management executives. Another aspect of the board of directors that has been emphasized is the representation aspect of the board in which it is proposed that all the shareholders of an organization ought to be represented in order to address the concerns of the stakeholders as much as those of the shareholders (Ferreira, 2015, p. 225). Moreover, the representation aspect also serves to increase accountability of the organization as a whole since all representatives will want to ensure the best outcome for their principals (Adams & Ferreira, 2009, p. 1-2). In other words, the representation aspect seeks to stem the perceived excesses of information asymmetry and conflicts of interests inherent in the agency theory. It is important to note at this point of the analysis that empirical literature has also analysed the benefits and costs of board diversity. Some of the benefits of board diversity include creativity and different perspectives to problem-solving, providing access to resources and organizational connections, career incentive through signalling and mentoring as well as public relations. The identified costs of board diversity include conflicts and lack of cooperation, conflicts of interest in the prioritization of organizational goals and associated costs of selection based on the demographic characteristic to ensure diversity (Ferreira, 2015, p. 227 - 228). The role of the Board of Directors broadly revolves around organizational decision-making and problem-solving. According to Kennon (2016), the primary responsibility of the BODs is to undertake activities directed at protecting shareholders’ assets and ensure shareholders receive decent returns for their investments in a company. The board of directors is tasked with the monitoring role in which the board undertakes evaluation and performance of an organization’s senior managers to ensure that they are professionally competent and are committed to organizational objectives in which the board can undertake the hiring, firing and assessment of the senior management in an organization (Solomon, 2007, p. 73; Adams et al, 2008, p. 7). However, there are empirical studies that appeal to the role of directors as the highest management organ of companies. According to Adams et al. (2008), “directors serve as a source of advice and counsel, serve as some sort of discipline, and act in crisis situations” often providing wise counsel whenever a firm faces a problem in a discipline in which one of the members has expertise (p. 6). Nonetheless, some scholars feel that the most important role of the board of directors is to facilitate transitions during organizational change processes such as planning a chief executive officer succession plan to facilitate a successful transition (Russell, 2016, n.p). The Board of Directors, other than playing a monitoring and evaluative role, often serve as the providers of revenue used to run organizations, especially in situations where a company is owned by partners (Corbetta & Salvato, 2004, p. 119-134). In a phenomenal study examining the role of the board of directors and significance of board diversity, Ferreira (2015) observed that boards are important for approving major organizational and strategic decisions made by companies such as mergers and acquisitions (M&As), hiring and firing top executives as well as overseeing changes in an organization’s capital structure (p. 225). In summary, from the empirical studies assessed in this section, the major roles of the board of directors include: I. Hiring, firing and evaluating top managers in an organization. II. Undertaking CEO succession planning and ensuring a smooth transition III. Sanctioning key organizational and strategic decisions such as involvement of firms in mergers and acquisition IV. Taking political responsibility for the operations of the organization in specified jurisdictions V. Providing capital for the business and determining the capital structure of an organization VI. Providing wise counsel in organizational problem-solving through provision of diverse perspectives on predetermined outcomes Relationship between Board Diversity and Corporate Performance and Accountability Given the significance of board diversity as discussed in the preceding section of this paper, it is important to investigate the relationship between board diversity and organizational performance as well as accountability. This becomes necessary because board diversity has been espoused by empirical studies as being crucial to organizational performance, albeit with several other costs. In fact, board diversity in itself has been found to compromise the efficiency of the top management organ since competency plays second to diversity which is the operating element and is also vulnerable to conflicts of interest (Ferreira, 2015, p. 228). For this reason, this section of the paper provides empirical evidence on the perceived relationship between board diversity and organizational performance as well as accountability. Board diversity has a positive and significant correlation with the financial performance of organizations, especially when the board comprises highly educated members since it provides an impetus of the board structuring a corporate strategy that solves complex corporate problems and provides long-term solutions for perennial corporate problems (Fidanoski et al., 2014, p. 81-123). According to Rampling (2011), board diversity that ensures equitable gender representation is positively related to the financial performance of organizations. Other than the relationship between board diversity and financial performance of organizations, empirical studies have examined the significance of board diversity on its monitoring and evaluation role. Research outcomes have shown that board diversity is positively associated with effectiveness in the oversight role of boards of directors, especially in situations in which conflicts may arise at the management level that requires a broader range of opinions to be considered (Erhardt, Werbel & Shrader, 2003, p. 18). Essentially, diversity as an aspect of the board of directors influences the organizational performance through the provision of varying perspectives that lead to an integrative approach to solving organizational problems. Therefore, researchers point out that the provision of diverse perspectives in tackling organizational problems is a crucial mechanism through which board diversity positively influences organizational performance. Erhardt et al. (2003) are one of the few empirical studies investigating the board diversity-corporate performance nexus that provides responses to the question as to “how” board diversity actually influences corporate performance. Investigating the relationship between board diversity and corporate performance has been undertaken along the constructs of the roles of boards as well as the types of diversity in the board of directors such as gender, educational and functional diversity as well as the age and geographical diversities. For instance, investigating the impact of educational and functional diversity on corporate performance and accountability, empirical outcomes reveal that educational and functional diversity significantly and positively influences corporate performance when the complexity of the economic framework in which a business operates increases and becomes more complex. Moreover, the educational and functional diversity has been found to influence firm performance through mechanisms such as innovation and complex problem-solving (Eulerich, Velte & Van Uum 2014, p. 29). The most dominant mechanism through which board diversity seems to influence organizational performance as revealed in most research studies is the power associated with adopting diverse perspectives in organizational problem-solving. A board of directors that comprises a diversity of any form is better positioned to comprehend the complexities presented in the business environment and subsequently make astute decisions, and also promotes the formation of mutual global relationships (Carter, Simkins & Simpson, 2003, p. 36). The outcomes of empirical studies, therefore, view different perspectives in organizational problem-solving as the essence of board diversity. On the impact of board diversity on accountability, most researchers have noted that diversity improves accountability in an organization because the directors in most instances act as agents of different stakeholders in an organization. For instance, the board of directors might comprise a representative of the employees of the business, customers, shareholders, the state and the community. According to a report provided by the United States Government Accountability Office (GAO), the companies that had gender diversity, particularly a better representation of women, were found to exhibit a high level of accountability to the compliance authorities and shareholders (GAO, 2015, p. 1). It has also been noted that the primary role of the board as the ultimate decision-making organ of corporates as well as its authority to hire and fire the top management places it in a better position to demand accountability from the senior managers thereby leading to a trickle-down effect for performance and ethical accountability in organizations (Bear et al., 2010, p.207-221; Fairfax, 2005, p. 795; Gazley, 2010, p. 610-620). Other than the appeal to authority and representation aspects of board diversity that influence accountability, empirical studies have also studied other mechanisms through which board diversity leads to accountability in corporates. For instance, it has been espoused that board diversity increases the trust of investors in an organization, boosts a firm’s reputation and good governance, complete with monitoring and evaluation strategies that have the spiral effect of increasing the levels of accountability in an organization (Rhode & Packel, 2014, p. 393). In particular, diversity on the dimensions of gender in which the number of women increases has been found to increase corporate accountability, especially concerning finances and regulatory compliance (Carter, Simkins & Simpson, 2003, p. 51). It is important to note at this point that there exists a consensus in empirical outcomes to the extent that diversity of the board of directors generally increases accountability in organizations. Shareholder Activism and Corporate Governance Shareholder activism, which refers to the means and mechanisms through which shareholders can exert their power as the owners of an organization to influence its operations, is a significant determinant of the governance methods used in different organizations. In fact, proponents of shareholder activism posit that organizations with active and engaged shareholders are usually very successful because the notion of active shareholders can alleviate managerial and boardroom complacency (ECGI, 2016, n.p). Shareholder activism has however been found to increase governance and by extension, organizational performance through increased accountability of the management to shareholders, albeit in the short run (Gillan & Starks, 2000, p. 275-305). The rationale for shareholder activism has been attributed to the agency problem in which the aspects of ownership and management of companies being separate resulted in skewed powers in running and managing the corporates. Empirical studies show that shareholder activism results in improved governance because shareholders often demand performance because much as shareholders have the theoretical ability to monitor organizations, the possibility to influence organizational change mechanisms are often impaired by staggered boards, restrictions on shareholder proposals as well as regulatory frameworks (Otto & Dan, 2014, p. 10). A critical review of literature materials in examining the relationship between shareholder activism and governance reveals that the main mechanism through which shareholder activism influences governance is through increased accountability which alleviates boardroom complacency. Moreover, the studies reveal that the perennial managerial problems of agency theory in which the board of directors and the company management act as trustees of shareholder wealth is the root cause of all forms of shareholder activism. According to Black (1998), shareholder activism affects organizational performance by influencing agency costs, legal rules, information costs, institutional competence and problems of collective action. Shareholder activism has also been found to condition a more inclusive and transparent governance structure since the vigilance of shareholders leads to changes in an organization’s policies. Shareholder activism, in the disguise of hedge fund activism, improves the financial performance of an organization by improving the operating performance of firms, increasing payouts, reducing agency costs and heightening the discipline of the Chief Executive Officer (Cossin, 2013, p. 10). However, shareholder activists, also referred to as controlling shareholders in some empirical studies, were found to impair the operational efficiency of the firm and upset the organizational equity in instances where the controlling shareholders practice opportunism at the expense of minority shareholders (Bebchuk & Weisbach, 2012, p. 14). Conclusion This paper has discussed the rationale for adopting a hierarchical organizational management structure with the board of directors at the apex. Moreover, it has been shown that the major roles of BODs include the hiring, evaluation and firing of senior managers, building the capital structure of organizations and undertaking succession planning to enable successful managerial transitions. Board diversity has also been discussed as a very critical aspect of the board of directors in which a review of empirical studies shows that diversity is significantly and positively related to corporate performance and accountability. Moreover, this paper has also established that shareholder activism influences corporate governance through the demand for accountability that reduces boardroom and managerial complacency. However, the outcomes provided in this paper should be comprehended in light of the challenges that face research in this discipline since boards perform different functions in different ways, making it difficult to establish on a consistent relationship between board diversity and corporate performance (Rhode & Packel, 2014, p. 393). Nonetheless, board diversity has been found to influence organizational performance, albeit through different mechanisms. References List Adams, R., Hermalin, B.E. and Weisbach, M.S., 2008. The role of boards of directors in corporate governance: A conceptual framework and survey (No. w14486). National Bureau of Economic Research. Retrieved on February 4, 2016, fromhttp://www.nber.org/papers/w14486.pdf Adams, R.B., and Ferreira, D., 2009. Women in the boardroom and their impact on governance and performance. Journal of financial economics, 94(2), pp.291-309. Bear, S., Rahman, N. and Post, C., 2010. The impact of board diversity and gender composition on corporate social responsibility and firm reputation. Journal of Business Ethics, 97(2), pp.207-221. Bebchuk, L.A. and Weisbach, M.S., 2012. The state of corporate governance research. In Corporate Governance (pp. 325-346). Springer Berlin Heidelberg. Retrieved on February 4, 2016, fromhttp://www.law.harvard.edu/programs/olin_center/papers/pdf/Bebchuk_652.pdf Black, B.S., 1998. Shareholder activism and corporate governance in the United States. As published in The New Palgrave Dictionary of Economics and the Law, 3, pp.459-465. Carter, D.A., Simkins, B.J. and Simpson, W.G., 2003. Corporate governance, board diversity, and firm value. Financial review, 38(1), pp.33-53. Corbetta, G., and Salvato, C.A., 2004. The Board of Directors in family firms: one size fits all?. Family Business Review, 17(2), pp.119-134. Cossin, D. 2013, Shareholder Activism Background Literature Review. IMD. Retrieved on February 4, 2016, fromhttps://www.imd.org/uupload/IMD.WebSite/BoardCenter/Web/212/Literature%20Review_Shareholder%20Activism.pdf ECGI, 2016, Shareholder Activism, Retrieved on February 4, 2016, fromhttp://www.ecgi.org/activism/ Erhardt, N.L., Werbel, J.D. and Shrader, C.B., 2003. Board of director diversity and firm financial performance. Corporate Governance: An international review, 11(2), pp.102-111. Eulerich, M., Velte, P. and Van Uum, C., 2014. The Impact of Management Board Diversity on Corporate Performance. An Empirical Analysis for the German Two-Tier System. An Empirical Analysis for the German Two-Tier System (November 8, 2013). Problems and Perspectives in Management (PPM), 12, pp.25-39. Fairfax, L.M., 2005. The Bottom Line on Board Diversity: A Cost-Benefit Analysis of the Business Rationales for Diversity on Corporate Boards. Wisconsin Law Review, p.795. Ferreira, D. 2015, Board Diversity. Retrieved on February 4, 2016 fromhttp://personal.lse.ac.uk/FERREIRD/Board%20Diversity%20version%201.pdf Fidanoski, F., Simeonovski, K. and Mateska, V., 2014. The Impact of Board Diversity on Corporate Performance: New Evidence from Southeast Europe. In Corporate Governance in the US and Global Settings (pp. 81-123). Emerald Group Publishing Limited. Gazley, B., Chang, W.K. and Bingham, L.B., 2010. Board diversity, stakeholder representation, and collaborative performance in community mediation centers. Public Administration Review, 70(4), pp.610-620. Gevurtz, F.A., 2004. Historical and Political Origins of the Corporate Board of Directors, The. Hofstra L. Rev., 33, p.89. Retrieved on February 4, 2016, fromhttp://www.hofstra.edu/pdf/law_lawrev_gevurtz_vol33no1.pdf Gillan, S.L. and Starks, L.T., 2000. Corporate governance proposals and shareholder activism: The role of institutional investors. Journal of Financial Economics, 57(2), pp.275-305. Government Accountability Office (GAO), 2015, Strategies to Address Representation of Women Include Federal Disclosure Requirements. Retrieved on February 4, 2016, fromhttp://www.gao.gov/assets/680/674009.pdf Otto, L., and Dan M, 2014, Shareholder Activism: Can it be an Effective Governance Mechanism? Retrieved on February 4, 2016, from http://arc.hhs.se/download.aspx?MediumId=802 Rampling, P.N., 2011. Board Diversity & Corporate Performance. Available at SSRN 1969229. Rhode, D. and Packel, A.K., 2014. Diversity on corporate boards: How much difference does difference make?. Delaware Journal of Corporate Law (DJCL), 39(2), pp.377-426. Russell, 2016, Different Is Better: Why Diversity Matters in the Boardroom. Retrieved on February 4, 2016, fromhttp://www.russellreynolds.com/insights/thought-leadership/different-is-better-why-diversity-matters-in-the-boardroom Solomon, J., 2007. Corporate governance and accountability. John Wiley & Sons. Retrieved on February 4, 2016, from http://www.untag-smd.ac.id/files/Perpustakaan_Digital_1/CORPORATE%20GOVERNANCE%20Corporate%20Governance%20and%20Accountability.pdf Walt, N. and Ingley, C., 2003. Board dynamics and the influence of professional background, gender and ethnic diversity of directors. Corporate Governance: An International Review, 11(3), pp.218-234. Read More