The Importance of Board Independence (IVOR nr. 90) 2012/3.4.0:3.4.0 Introduction

The Importance of Board Independence (IVOR nr. 90) 2012/3.4.0

3.4.0 Introduction

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Whereas the agency theory focuses on the behaviour of an individual agent and regards the company as a nexus of contracts, the transaction costs economics (TCE) theory focuses on transactions themselves as units of analysis and regards the company as a governance structure (Stiles and Taylor 2001: 14). Despite this difference in object of analysis, the attitude towards management is comparable. Both theories depict management as human beings pursuing self-interest and utility maximisation (Donaldson 1990: 379). Subsection 3.4.1 treats the TCE theory itself and subsection 3.4.2 elaborates on the board composition, which is prescribed by TCE theorists. Table 3-2 first gives a short summary of the TCE theory, which is worked out further in the remainder of this section.

Table 3-2: Summary of the main characteristics of the transaction costs economics theory.

Description of theory

The transaction costs economics theory states that the existence of companies is due to shortcomings of the price mechanism. Especially the existence of transaction costs means that transactions – up to a certain level – can better be carried out within a company than in the market.

Problem

Within a company a certain number of transactions are carried out. The interests of the suppliers of the assets used in these transactions need to be protected.

Solution

The TCE theory distinguishes transaction-specific and non-transaction-specific assets. Suppliers of non-transaction-specific assets can easily redeploy their assets after termination of a contract, whereas suppliers of transaction-specific assets cannot. The latter group of suppliers needs either a safeguard or protection in the form of a position on the board. All suppliers of assets can be protected in a certain way, except shareholders. In order to protect shareholders’ interests, the board should act with the interests of shareholders in mind. Furthermore, managers are special, because management and the company are generally seen as one. Therefore independent supervision is necessary to monitor management.

Focus on independence

Supervision by independent NEDs is necessary to monitor management and managers on the board of directors. These independent NEDs should protect the interests of shareholders. The focus on independence in the TCE theory can therefore be regarded as important.

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