The Importance of Board Independence (IVOR nr. 90) 2012/3.8:3.8 Conclusion

The Importance of Board Independence (IVOR nr. 90) 2012/3.8

3.8 Conclusion

Documentgegevens:

N.J.M. van Zijl, datum 05-10-2012

Datum: 05-10-2012
Auteur: N.J.M. van Zijl
JCDI: JCDI:ADS600609:1
Vakgebied(en): Ondernemingsrecht / Algemeen
Ondernemingsrecht / Corporate governance

(Consideration 3.1) Independence is a very important subject for the agency theory and TCE theory. These two theoretical frameworks prescribe high levels of board independence with the aim to have strong monitoring in order to improve the (financial) results of the company. The stewardship theory, resource dependence theory and stakeholder theory do not attribute importance to independence. Therefore, the answer to the research question about the aim of independence is heavily dependent onthe attributed importance in the economic theoretical framework that is used.

The question about the aim of independence is only relevant in an agency theory and TCE theory framework. In these two frameworks, the agent, director or manager is considered to be self-interested and utility maximising. Therefore, in order to mitigate agency costs, the establishment of boards with high levels of board independence is advised, with the aim to improve monitoring on the board. Independent monitoring discourages agents from pursuing their own interests and independent directors can intervene when they observe self-interest driven behaviour of agents. This diminishes agency costs and is consequently expected to lead to better performance of the company and higher returns for the shareholders. In addition, the TCE theory in some cases advocates information participation membership of the board for representatives of stakeholders with transaction-specific assets without other protection.

(Consideration 3.2) Stewardship theorists advise having directors from inside the company on the board, because these directors have knowledge of the company that is needed for high-quality decision-making. Resource dependence theorists advise inviting members on the board of companies or organisations, which the company depends on in order to control these sources of dependence. These board members from inside the company or board members from dependent companies or organisations are not independent. According to the stewardship theory, board independence should actually be low for the benefit of the performance of the company. Therefore, the ideas about optimal board composition of the stewardship theory and resource dependence theory proponents focus on other subjects than independence. (Consideration 3.3) If independence is not important in an economic theoretical framework, the question about the aim becomes less relevant.

(Consideration 3.4) The stakeholder theory focuses on how stakeholders are considered and does not have a view on board composition. It does not attribute importance to independence and has no view on the aim of it. This view on all stakeholders might contrast with the agency theory, TCE theory, stewardship theory and resource dependence theory that have the shareholder or the company in general in mind when decisions are made. However, within the stakeholder theory two groups exists with different views on this matter. The first group comprises proponents of the strategic stakeholder interpretation that also aims to look after shareholders’ interests and uses stakeholder management in an instrumental way to serve shareholders’ interests. This interpretation of the shareholder theory does not differ with respect to objective from the other four theories. The board composition should therefore be in accordance with the board composition in either an agency theory framework or the stewardship theory framework. The second group comprises proponents of the multi-fiduciary interpretation and the new stakeholder synthesis, both of which aim to serve the interests of all stakeholders. In order to ensure that the interests of all stakeholders are looked after, the proposed board composition in a TCE theory framework is recommended. The TCE theory framework focuses on independence.

The differences between the five theories are summarised in Table 3-8 at the end of this conclusion. Although the agency theory and TCE theory attribute importance to independence and have views on board composition that are in accordance with the importance, the stewardship theory and resource dependence theory have views on board composition as well. All these four theories and the strategic stakeholder synthesis theory aim to serve the company and the shareholders with their proposed board composition. Whether the focus on independence, or other factors, is truly beneficial to the company is unclear. Therefore, chapter 4 gives a literature review of studies that relate board independence to financial performance of the company. It addresses the research question about the consequences of board independence. In order to give a quantitatively grounded answer to the research question as well, chapter 5 analyses the findings in literature in a meta-analytic study. These two chapters must show whether the attributed importance of independence by the agency and TCE theory is correct, based on the relationship between independence and companies’ financial performance.

Table 3-8: The major contributors, description of the theory and the advocated board composition of the agency theory, transaction costs economics theory, stewardship theory, resource dependence theory and stakeholder theory.

	Agency theory	Transaction costs	Stewardship theory	Reso urce dependence	Stakeholder theory
Major contributors	Berle and Means (1932), Jensen and Meckling (1976), Fama (1980), Fama and Jensen (1983)	economics theory Coase (1937), Williamson (1984; 1985)	Donaldson (1990), Donaldson and Davis (1991; 1994), Davis et al. (1997), Muth and Donaldson (1998)	theory Pfeffer (1972), Pfeffer and Salancik (1978), Mizruchi (1996)	Freeman (1984; 1994), Freeman and Evan (1990), Goodpaster (1991), Boat-right (1994), Donaldson and Preston (1995), Jensen (2002)
Description	Separation of ownership and control between principals and agents leads to the agency problem and causes agency costs, because both groups aim to maximise their own utility. Alignment of interests and independent monitoring should mitigate the agency problem and minimise agency costs.	The subject of analysis is the transaction and the company is a governance structure. The allocation of production factors is determined by the price mechanism. The reason of existence of companies is transaction costs, which are the costs of using the price mechanism. Managers are regarded as self-interested and utility maximisation pursuing human beings.	The manager is a good steward for the company’s resources and assets, and a trustworthy individual who aims to do a good job. Agency costs are minimised by the manager, because of the fear of ruining his reputation by harming shareholder interests.	Cooptation is a good tactic of managing the interdependence between organisations, which can be implemented by inviting directors of interdependent organisations on the board. Rationale is that the most direct method for controlling dependence is to control the source of that dependence.	All stakeholders are considered in decision-making. Strategic stakeholder synthesis regards stakeholders as instrumental and uses them in order to serve shareholders’ interests. The multi-fiduciary interpretation and the new stakeholder synthesis aim to serve the interests of all stakeholders.
Board composition	Larger proportion of independent directors and separation of CEO and chairman positions.	Stakeholders with transaction-specific assets either need a safeguard or protection by a seat on the board. In addition independent NEDs should be part of the board to monitor management on behalf of the shareholders.	Larger proportion of executive directors and a combined CEO and chairman position.	The board should consist of representatives of interdependent organisations.	The strategic stakeholder synthesis allies with the agency and stewardship theory, when board composition is concerned. The multi-fiduciary interpretation and the new stakeholder synthesis ally with TCE.
Importance of independence	Very important	Very important	The lack of independence is important	Not important	Not important

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