Director networks/director selection: The board's strategic role

Pergamon

0263-2373(94)00060-3

Eurqw~ Manapnent \ournal Vol. 13, No. 1, pp. 79-90, 1995 Copyright 0 1995 Elsevier Science Ltd

Printed in Great Britain. All rights reserved 0263-2373/95 $9.50+0.00

Director Networks/Director Selection: The Board’s Strategic Role DONALD O’NEAL, Assistunt Professor of Management, Sangumon State University, Illinois; HOWARD THOMAS, Dean and Juames F. Towey Professor of Strategic Management, University of lllinois at Urbana-Champuign

The strategic role of the board of directors is gaining renewed research attention. It may be significantly influenced by the process of selecting directors and by multiple board memberships (interlocks). Donald O’Neal and Howard Thomas describe a research project in which a series of

personal interviews with board members offers new insights into the board’s strategic role.

Introduction The role of the board of directors in corporate governance has been abundantly discussed in the Finance (Burt, 1983, Jensen, 1989,1991), Economic (Berle and Means, 1932, Williamson, 1985), Legal (Fama and Jensen, 1983) and, to a lesser extent, Business Policy and Strategy (Andrews, 1979,1980,1981,1987, Porter, 1980, Vance, 1983) literature. The hostile takeovers of the 1980s drew increasing attention to the role of boards, and to the question of whether or not they were diligently performing what was perceived to be their primary fiduciary responsibility, namely, overseeing shareholder interests and maximizing shareholder wealth.

There is general agreement that the board has three primary roles - control, advise/counsel, and strategic (Mace, 1971, Andrews, 1987). The roles of control and advise/counsel have been discussed broadly and in great detail, but analysis of the board’s strategic role has focused almost entirely on the context of overseeing or ratifying strategy, largely ignoring the possibility of a more active role in strategy formulation.

In addition, although it is widely acknowledged that many directors serve on more than one board, little attention has been addressed to the strategic role and impact of directors serving simultaneously on multiple boards, except from the perspective of their potential for facilitating cooperation between competing firms (Pfeffer, 1972, Pennings, 1980, Zahra and Pearce, 1989). ‘Networks’ and ‘networking’ will be generally utilized in this paper, when referring to multiple-board service, rather than the somewhat questionable term ‘interlocking directorships’.

A profusion of literature on the corporate governance process (Berle and Means, 1932, Burt, 1983, Williamson, 1985) and on boards of directors (Mace, 1971, Vance,

EUROPEAN MANAGEMENT JOURNAL Vol13 No 1 March 1995 79

DIRECTOR NETWORKS/DIRECTOR SELECTION

1983, Andrews, 1987) examines in great detail how boards are supposed to work, but provides very little information on how board processes actually function. To help illuminate this area a pilot study was designed to explore board processes, with particular regard to director networks and director selection, from the perspective of those who actually serve on boards.

Figure 1 shows important elements in the board configuration process. It is intended to illustrate cause-and- effect relationships between important input variables and the director-selection process, and between the director-selection process and corporate outputs, notably those indicative of performance.

This paper first reviews relevant literature and examines research issues, then describes and discusses the findings of the research study. This is followed by a summary of findings and implications for further study.

Literature Review This section highlights the literature that appears most relevant to director selection, director networking, and the strategic role of the board. The importance of these three elements, the relationships between them, and how they affect the board configuration process are graphically depicted in Figure 1. In short, the role of the board, as perceived by those responsible for selecting directors, is a primary determinant of how the director selection process will operate. For example, the required qualifications for directors being sought to serve on a board whose primary role is advising top management may be substantially different than qualifications for directors whose board will be more strategically- involved. In either case, director networks have been, and continue to be, the dominantmeans of identifying candidates for board seats.

A summary of the literature in tabular form is presented in the first column of Table 1.

Boards of Directors The task of contrasting theoretical and practical wisdom on the functions and authority of the board of directors has been addressed by numerous authors (Mace, 1971; Andrews, 1987; Baysinger and Hoskisson, 1990; Eaton, 1990). While it is often assumed that the primary role of board members is to guide the firm and provide CEO succession, this research shows that attention to those tasks is often sporadic or non-existent and, when it does OCCLU, it is constrained by tradition and rules of courtesy. CEOs, not directors, usually choose their successors and set firm objectives. Moreover, CEOs are usually responsible for choosing the directors, themselves. As a result, the intentions of the party responsible for selecting directors may have more to do with how the board is utilized than traditional explanations, such as board composition, would suggest.

- chairmanship (CEO vs outsider) - Committees

1 pirector se1ectipo - criteria - acceptance

- competitiveness - rewtation

-

L

Figure 1 Board Configuration Process

Director Networks Interlocking directorates link companies in three primary ways: ownership, in which two organizations are jointly controlled by one board; direct interlocks, in which two organizations share one or more board members; and indirect interlocks, in which directors of two firms both serve, for example, on a third firm’s board. Burt (1983) describes interlocks as increasing the organization’s access to competitive information, while Aldrich and Herker (1981) define them as ‘linking the organization to target groups in its environment, in a visible way, so they will feel their interests are represented’.

Pfeffer (1972) also acknowledges the environmental network created by interlocks, though his emphasis is on the power interlocks offer a firm in co-opting other organizations on which the firm is dependent. Others have viewed interlocks as mutually-beneficial interorganizational relationships (Zahra and Pearce, 1989; Schoorman, Bazerman and Atkin, 1981), power- enhancing vehicles for organizations and individuals (Pennings, 1980; Warner and Unwalla, 1967), sinister tools of the elite class (Useem, 1984), ties of co-option (Burt, 1983) and sanctuaries of ‘group think’ (Janis, 1971).

A less polarized view of director interlocks is offered by Bazerman and Schoorman (1983), who suggest a ‘limited rationality’ model which looks at interlocks through the cost/benefit tradeoffs of three parties: the interlocking director, the interlocking organizations, and

80 EUROPEAN MANAGEMENT JOURNAL Vol 13 No 1 March 1995


Table 1 Literature, Research Issues and Flndlngs

Literature Review Research Issues Survey Findings

Director Selection (Mace, Andrew% Eaton, Boulton, Woods)

- How (by whom) selected?

- Selection criteria?

- How recruited?

- Role of strategy?

- Chairman (if CEO) (varies if chairman is outsider)

- primarily subjective (compatibility, collegiality, etc)

- mostly top people - some ‘comers’ - primarily networking

- not evident - talk of changing to more expertise-

based selection (from ‘cronyism’ and ‘good-old-boy’ networks), but little evidence

Director Networks (Pfeffer, Burt, Zahra & Pearce, Pennings, Schoorman, et al)

- Implications of multiple-board service?

- dominant force in director selection

- seems ‘invisible’ to those involved

Strategic Roles of the Board - What are they, or have they been - primarily ‘emergent’ strategies; (Andrew% Henke, - intra-industry cooperation Zahra & Pearce, Baysinger & Hoskisson, Aldrich & Herker, Molz, Pinnell, Tashakori & Boulton) - What could they be? - more deliberate (planned) strategies:

- strategic alliances - information & technology

‘mainstreaming’ - boundary spanning - stakeholder networking - environmental ‘buffering’ - uncertainty reduction

- How - strategic selection of directors

society. Finally, Davis and Powell (1992), in their review of interlocks, suggest two distinct perspectives: (1) interorganizational, in which organizations are the primary actors and individuals act as their agents, and (2) intraclass, in which individuals are the primary actors and organizations are their tools.

The Strategic Role of the Board While the degree and manner in which boards of directors are, or should be, involved in firms’ strategy is an issue of debate for organizational researchers, most agree a role does exist for those willing to act on it, as expressed by Andrews, (1987). Zahra and Pearce (1989) describe the strategic role of boards as boundary- spanners, with access to information vital to diagnosis of opportunities and threats. Pennings (1980) suggests that interlocking directorates are used to assure a continuing supply of resources.

The findings of Demb and Neubauer (1992) confirm board involvement in formulating strategy. They asked 71 directors ‘Are you involved in setting strategy for the company?‘. Although the vast majority answered ‘Yes’, the degree and type of involvement was not tested in the study.

Andrews has long been a leading proponent of board involvement in corporate strategy (1979, 1980, 1981, 1987). He was an early advocate of the formation of board strategy committees. However, he is firm that this involvement should be restricted to reviewing strategy - the strategy that has been formulated by management. Similar distinctions in strategic action are made by Mintzberg (1994) when he distinguishes strategic planning as analysis, and strategic thinking as synthesis. ‘The outcome . . is an integrated perspective of the enterprise, a not-too-precisely articulated vision of direction’. Aram and Cowen (1986) support this view,



although describing it as strategy formulation, as does Rosenstein (1987).

On the other side of the issue, there are a number of researchers who see a larger role for board members in strategy formulation, Lauenstein (1982), for instance, suggests that ‘the decision as to how much cash to invest in the business and how much to pay out as dividends is a fundamental element of corporate strategy’. He states that, as a result, the board is a primary strategic player. Henke (1986) feels that most, if not all, boards influence numerous strategy-related decisions, frequently without realizing their involvement.

Boulton (1983) sees the board’s responsibility as institutional self-renewal - continuity of the institution, but within the established/desired institutional philosophy. Rosenstein (1987) describes four cases in which boards have been successfully involved in strategy, to different degrees, yet says the board should not have a high degree of involvement in strategy - that there is ‘general agreement that the board is not a proper locus for making or originating strategy. He sees the board’s major role as replacing the CEO, if ‘results . . . do not confirm the existence of a successful strategy’. The authors caution that responses reflect differences in individual interpretations of ‘involved in setting strategy’ as well as different degrees of involvement.

There are, on the other side of the issue, a number of researchers who, either explicitly or implicitly, see the board’s responsibilities including involvement in strategy formulation. Lauenstein (1982), for instance, suggests that ‘the decision as to how much cash to invest in the business and how much to pay out as dividends is a fundamental element of corporate strategy’. Rejecting the often ‘automatically accepted’ objective of many organizations - growth - Lauenstein (1983) suggests another strategic responsibility of the board as determining whether or not growth is healthy. Henke (1986) feels that most, if not all, boards influence numerous strategy-related decisions but perhaps frequently without realizing their involvement.

Tashakori and Boulton (1983) are increasing pressure on boards to become more active in articulating mission and strategies, but that this is resisted by CEOs who do not want effective/involved boards. Their research shows that the degree of board involvement in strategic issues is positively correlated with information availability, board performance-evaluation, and a majority of outside directors. Molz (1985) offers the board as the only group that can balance the objectives of owners, managers and society without losing sight of the fundamental objectives of the firm.

Pinnell (1986) argues that the board’s role in defining the organization’s future is expressed through the definition of corporate objectives and strategy, the establishment of the planning approach, and the examination of plans. Penbera and Bonner (1990) support board strategic planning committees specifically

for the purpose of minimizing reactive behavior by the board when the firm becomes an acquisition target. Judge and Zeithaml(1992) find that the boards’ strategic involvement increases with the firm’s age, but decreases with an increase in the size of the board, the number of inside directors, and the level of diversification.

These perspectives discuss what boards are supposed to do and what they actually do but, almost without exception, the analyses are based on secondary data rather than an inside perspective.

I Research so far has had little guidance to offer managers in designing and using their boards of directors for the company’s best strategic advantage

Director Selection Monks and Minow (1991) describe a gap between the theory and reality of what boards do, a gap that is even more evident in the director selection process. Although much has been written on the topic, little of it concerns how the selection process really operates. Director networks, for instance, are frequently discussed from perspectives such as their potential for facilitating cooperation between competing firms (Burt, 1983, Zahra and Pearce, 1989), and their role in assuring access to critical resources (Pfeffer, 1972, Pennings, 1980). The role of networks in director selection, however, has seldom been considered.

Expecting directors to serve as management’s ‘window to the world’ (Andrews, 1980) requires recruiting, as directors, ‘boundary spanners’ who are members of, or in contact with, specific target groups (Aldrich and Herker, 1981). Boulton (1983) emphasizes the importance of recruiting directors who are knowledgeable about the overall functioning of corporations. He believes the board should strive to achieve an appropriate balance in expertise and experience in its composition.

Research on director selection has been limited in its contribution toward an understanding of appropriate director-selection criteria. Yet we know that some firms have addressed this issue in a systematic and apparently successful manner. Witness Baker Hughes Inc.‘s process to ensure the selection of an objective, talented, truly independent board (Woods, 1991). The process includes an assessment of current board skills using 15 specific criteria. Tabulation of the evaluation results helps identify areas where specific board skills need to be enhanced. Pre-identified criteria are also used to identify potential board members, and the company has a well- defined nominating process. These commitments keep the board interested, workable, and independent.

Nominating Committees Based on an examination of proxy statements released



prior to 1979 shareholder meetings, Mueller (1979) announces that ‘the nominating committee has arrived as an active arm of the corporate board of directors’. He suggests that this advent necessitates a system for the performance evaluation of current directors and a review of the qualifications of prospective directors. Andrews (1987) sees the active participation of nominating committees as a factor in the increasing the independence of boards. Rosenstein (1987) says the rapid growth of board nominating committees during the 1970s has reduced the perception that CEOs hand-pick their directors. 32% of boards had nominating committees by 1979, compared with only 8% in 1971.

ultimately led to nine additional interviews, with members of those same boards. Conducted in 1992, these interviews utilized open-ended questions rather than seeking answers to specific questions.

Although the trend to nominating committees seems to be continuing (Verespej, 1994), there remains substantial concern about how much of a role they actually play and how effectively they are utilized. In spite of the fact that more than half of boards now have nominating committees that meet once or twice a year, Charkham (1994) expresses concern about the continued perception that CEOs dominate the board-appointment process. Charkham’s concern is reinforced by the results of a 1992 Corporate Governance survey sponsored by the National Association of Corporate Directors (NACD). Responses from more than 600 CEOs suggest that 51% of all nominating committees are operating without written charters, and more than half of those responding disagree with the suggestion that nominating committees should be composed entirely of independent outside directors. This may suggest that a majority of CEOs are still reluctant to relinquish control over the selection of directors.

The directors responded from the combined experience of 55 directorships (32 current and 23 former), on 46 boards (23 current and 23 former). At the time of the interviews, the directors served seven publicly-traded firms and two which were privately held. Annual revenues ranged from a few million dollars to several billion, with both privately-held companies positioned just below the $200 million mark. Their industries covered a broad spectrum, including manufacturing, communications, utilities, banking, education, trans- portation, healthcare, insurance, and construction.

While there are many unanswered questions about multiple board memberships, this research was designed to focus on the following areas, which were felt to be most significant in examining the strategic role of boards: board responsibilities; composition; selection; reasons for accepting directorships; director networks; and the role of the board chairman. The key research questions are presented in Table 2. We hope the delineation of these questions defines new areas of interest for both strategy researchers and business practitioners.

Although three of these streams of research - director networks, director selection, and nominating committees - seem to have causal implications for the fourth - the strategic role of the board, the research has generally not examined these relationships either first-hand, or to any significant degree. As a result, we still have little to offer management practitioners in the way of guidance on how to configure and utilize boards of directors to their firms’ strategic advantage.

This research was designed around the principle of ethnography, which is defined as ‘the work of describing a culture’ (Spradley, 1979). Interviews for this study sought the subjects’ descriptions of the culture of their boards, entirely from their individual perspectives, largely without interviewer influence. The list of key research questions (Table 2) was used in a contingency fashion, to be asked only if time permitted after the directors had completed their non-prompted comments. From this perspective, all areas of Figure 1 were open to discussion, depending on the directors’ perceptions of the issues that seemed most important, or interesting, to them.

Research Issues Although the literature review tends to confirm prior impressions that board networks may play a significant role in some board actions, it doesn’t shed much light on more strategic types of board involvement. This then leads to the question ‘What roles do director networks play in board actions?‘. It seems important to learn, from directors’ perspectives, what they think are the most important board issues. Accordingly personal interviews were conducted with a sample of 18 directors who serve, or have recently served, on the boards of for-profit companies in the United States.

Some interviewees requested questions to which they could respond. Usually a single non-specific question was sufficient to trigger a substantial amount of dialogue, and it seldom took more than one or two questions to elicit an hour or more of discussion. Most, if not all, of the research questions were usually spontaneously addressed during the course of the interview.

The three columns of Table 1 provide a framework for linking research issues with the literature review, and with survey findings.

Observations With the intention of gaining entry to at least six boards Since the detailed results of this survey are too in different industries, ten directors were initially comprehensive to be addressed in their entirety in this contacted through introductory letters. These contacts paper, the findings have been condensed here to those resulted in nine interviews. The initial interviews associated with director selection, director networks,



Table 2 Research Questlons

Responsibilities:

Composition:

Selection:

What are the responsibilities of the board, and of individual directors, as perceived by the chairman, and by the individual directors?

What are the advantages, and disadvantages, of both outside and inside directors, as perceived by the chairman, and by the individual directors?

How are directors selected? Who is responsible for selection? What are the selection criteria? How are candidates identified?

Accepting directorships: Director networks:

To what extent do corporate strategies influence the selection process? To what extent are memberships on other boards a criteria for selection?

What are the reasons people agree to serve on boards? What are the advantages, and disadvantages, to directors, and to their boards, of serving on

more than one board?

Board chairmen:

To what extent do multiple board memberships play a role in key strategic decisions, such as CEO succession, acquisition, divestiture, and strategic alliances?

What are the advantages, and disadvantages, of having a chairman who is an outside director vs. one who is an inside director (CEO)?

board and director responsibiliities, and board composition.

Director Selection How are directors selected?; Who is responsible for selection?; What are the selection criteria?; How are candidates identified?; To what extent do corporate strategies influence the selection process?; To what extent do memberships on other boards influence selection?

In most cases, the individual serving as both the CEO and Chairman chooses the directors. When the Chairman was an outside director and not the CEO, we found one case of the CEO selecting the directors, including an outside Chairman, and another in which a director who was also the majority owner of the firm selected the directors and appointed an outside director as the Chairman. One director suggested that the board, itself, should select directors and the Chairman.

Selection criteria The consideration of prospective new directors appears to begin with rather subjective requirements, such as compatibility with existing board members, collegiality, high visibility, business success, good background, insightfulness, character, integrity, and image. Of these criteria, compatibility was repeatedly mentioned first, and seemed to stand out as these directors’ most important concern. Teamwork and non-adversarial relations were frequently mentioned as keys to board effectiveness. More objective and measureable criteria, such as balancing the mix of institutions, geographic areas, experience, constituencies, expertise, ages, business backgrounds, contacts, and leadership strengths seemed of secondary importance.

identification of candidates Those interviewed insisted that director selection is one of the most critical issues facing boards, and that it is a process that is changing from one of cronyism and good-old-boy networks to one of selection based on expertise. Yet, the only examples offered of directors recruited on the open market (e.g., using search firms) were two instances in which candidates were sought to become the first women on their respective boards. Otherwise, identification of candidates appears to have been almost exclusively through directors’ personal, professional, and social networks. Even board nominating committees relied almost exclusively on the recommendations of current board members.

Some directors emphasized the value of keeping a list of prospective board members - people they know they can work with, and who will maintain the collegiality that is so important. Most boards want the top people from other companies on their boards. Since there is often great demand for these individuals, and a practical limit to the number of board invitations one person can accept, a common selection strategy is picking tomorrow’s ‘comers’. In effect, the company gambles on which second-tier person in another company is most likely to be that firm’s next CEO.

Accepting directorships The number of boards on which the directors in our sample were currently serving (including their own) ranged from 1 to 4, with an average of approximately 1 3/4. Most described 3 as the maximum number of outside directorships to which they could do justice without diminishing the returns to their own business. As a result, some directors have more offers than they can accept.

The top reason given for accepting one offer over

84 EUROPEAN MANAGEMENT JOURNAL Vol13 No 1 March 1995


mother was the opportunity to learn from other :ompanies, industries, and board members. This was :ollowed closely by the candidate’s perception of his ability to make a contribution. Other reasons given included the opportunity to gain experience that could help in one’s own business; networking opportunities; honor/prestige (though, for some, this had been somewhat diminished by increasing liability); the opportunity to work with a particular kind of management group or a particular type of board; a good extension of a business career; and the opportunity for candid peer relationships (particularly for CEOs, who often find it lonely at the top).

Also important to prospective directors were feelings that the company and its management were honest; directors would be treated as independents, and feel comfortable disagreeing with the majority; directors’ inputs would be valued; and finally, the board would operate as a team. With concerns for demands on their time, potential liability, and their reputations, directors normally choose to serve a successful company rather than a troubled one. With reference to liability risk, one director questioned why anybody in their right mind would agree to serve as a director unless they had substantial ownership interests in the company. Additional factors influencing rejection of board seats may be government regulations or company policies concerning competitors, suppliers, customers and the like.

Overall, recruiting board members appears to be an increasing challenge, as fewer people feel that the benefits outweigh the liabilities. The degree of difficulty is likely to be inversely correlated with the relative success of the company.

Director Networks What are the implications, for directors and their boards, of serving on more than one board? What role do multiple board memberships play in key strategic decisions?

Other than one director’s observation that the opportunities for networking (which he referred to as a ‘business socialization process’) are a key reason for accepting directorships, the role of multiple board memberships was never addressed directly. Its influence was, however, pervasive throughout the interviews, particularly in the processes of identification and selection of directors. We surmise that networking may be such a pervasive and long-standing part of board processes that it has become more of an unconscious norm than a conscious strategy.

While these directors may not have been strategically selected for their networking potential, descriptions of their activities illustrate situations in which those networks were utilized to firm advantage. This phenomenon appears analogous to what Mintzberg (1978) describes as an emergent strategy.’ And similar

to boards which, although not consciously selecting directors because of their specific networking potential, benefit from those networks, executives who accept their first directorship with no particular strategy for which boards they hope to join often find they have expanded their individual networks by gaining entry to the world of board service. In fact, for that reason, one director suggested that director-candidates should not be too selective in turning down their first board invitation.

I Director networking plays a dominant role in the identification and selection of directors.

Board networks are also illustrated in cases where CEOs suggest their top executives as substitutes for the board seats they themselves are unable to accept. Primary benefits of company executives serving on outside boards include building alliances with, and learning more about, other industries or capabilities that are important to the success of their company. For example, an executive of an automobile manufacturer serving on the board of a petroleum company can be beneficial to both firms’ understanding of what is important to the other. Other board links connect subsidiary boards with their corporate mainstreams, rural firms with more cosmopolitan information and technology, and organizations with their communities. The latter strategy is often pursued by banks and utility companies.

Overall, it is apparent that director networking plays a dominant role in the identification and selection of directors. All directors interviewed, and most others to whom they referred, had been offered board seats through networking rather than through the recruiting channels that would be considered primary in the selection of corporate executives. Networks most frequently mentioned included board memberships, professional associations, social contacts, personal acquaintances, school ties, and family ties.

Responsibilities Since the roles of the board as a unit and the directors as individuals involve responsibilities and perceptions at two different levels, they are discussed here separately.

Board Maximizing shareholder wealth was mentioned first, by every director, as the primary responsibility of the board. Although only one director specifically amended that responsibility by adding ‘over the long-term’, the context in which it was discussed by most directors implied that philosophy. Two directors (both from the same board) emphasized the importance of balancing the interests of four stakeholder groups - shareholders, customers, community, and employees. This responsibility was echoed, implicitly, in the discussions of



Table 3 Board Responsibilities

Ensuring that the company has good management (management succession)

Evaluating management performance Providing/overseeing policy Determining proper management compensation Looking after the good name/well-being of the company Analyzing/ratifying management’s strategic plans/goals Macro-management of the company Balancing management responsibility and authority

(system of checks and balances) Forcing management to look ahead Assuring ongoing corporate purpose Setting the tone and direction of the company Serving as a corporate legal entity Anticipating and managing change and uncertainty Recognizing the social obligations of the corporation Providing corporate public relations and feedback Providing advice and consent to management Involvement in strategy creation and implementation.

several of the others interviewed. Other board responsibilities most frequently mentioned are listed in Table 3.

The emphasis on the importance of these perceived responsibilities varied considerably. While some may seem at variance with the goal of maximizing shareholder wealth in the short term, most can be visualized as contributing to that goal in the long term.

individual directors There was general agreement that a director’s first responsibility is to quickly learn enough about the corporation to be a useful and effective participant in board discussions. Next, most felt a director should be able to make a contribution. There was also a common observation that directors should behave in certain ways, or ‘fit in’. Other responsibilities include accepting board memberships ‘for the right reasons’, exercising sound judgement in weighty matters, keeping current on company activities, loyalty to the chairman (or resignation from the board), speaking up, and abstention from voting on issues that are not clearly understood.

Board Composition The opinion was strongly stated and near-unanimous that boards should be heavily weighted with outside directors. There was no clear consensus of how many inside directors, or who they should be. Those supporting some inside directors generally favored between one and three. If there is to be only one insider it should be the CEO; if two, the CEO and the President; if three, the CEO, the President, and either the CFO or an heir-apparent. Opinions spanned a broad spectrum. At one extreme was the perception that any management people at all on the board would diminish the degree of tension between the board and management

that is necessary to objectivity. At the other extreme was the perception that restricting the number of inside directors may place too severe a limitation on the breadth of inside information available to directors.

Opinions on directorships as means of grooming successors were mixed. Those in support felt it would be unfair to a future CEO to have not had prior board experience. Those in opposition felt it unnecessary to be a voting board member to get board experience, that the board’s role is to provide direction rather than day- to-day management, and that the greater the presence of inside directors, the greater the tendency of the board to micro-manage.

Closely-held, majority-owned, or private companies do not attach the same importance to having a majority of outside directors on their boards. Still, in recent years they have added outside directors to their boards. Reasons given include increasing board activity/ involvement, broadening the firm’s perspective, and adding new business skills.

Discussion Taken together, the interview responses illuminate several issues of importance to boards and directors.

Networking Individual networking as a board issue was seldom discussed directly, yet it appeared to be one of the most pervasive, and perhaps most influential, forces at work among directors. Although currently most evident in non-strategic applications, the potential of networking in strategic applications appears to be significant. Davis (1991) offers an example of a director interlock system acting as a diffusion mechanism for information and strategies. He supports the existence of such a network through an empirical analysis of the diffusion of the adoption of poison-pill amendments among US corporations.

Selection Selection of directors is the board process that currently appears to be most powerfully influenced by networking, as well as one in which networking offers meaningful strategic potential.

Involvement Board structure and composition have evolved, in recent years, from comparatively uninvolved/inactive boards toward more involved/assertive boards. This is particularly noticeable in those privately-owned companies that have added outside directors to their boards. This evolution may reflect a fundamental change of attitude: successful businesses, public and private, can no longer act in isolation. they increasingly need outside inputs to maintain corporate viability.

In the United States an increased interest in corporate



governance is exemplified by the active involvement of institutional investors in analyzing board performance, as well as corporate performance. CALPERS (California Public Employees’ Retirement System), the largest institutional fund in the US with investments exceeding 70 billion dollars, is a leader in promoting what has been termed the ‘political’ (Pound, 1992) or ‘democratic’ model of corporate governance (Pound, 1993). This model involves ‘relationship investing’, in which large investors become actively involved in two-way communi- cation with the CEOs and boards of the corporations in which they take ownership positions. By seeking ’ . . . friendly, ongoing conversations with management and the board about corporate policy and the makeup of the board of directors’ institutional investors can ‘. . . provide corporations with a reliable and friendly focal point in the market from whom to receive feedback’ (Pound, 1993).

In the United Kingdom, the Committee on the Financial Aspects of Corporate Governance (the Cadbury Com- mittee) was commissioned, by the Financial Reporting Council, the London Stock Exchange, and the account- ancy profession, to address the financial aspects of corporate governance (Cadbury, 1992). This was due to a low level of confidence in financial reporting, and lack of adequate auditing safeguards.

Just how involved individual board members become appears to be a function of how active their chairman wants them to be. The chairmen whose boards were represented in our sample appeared to favor active boards, several having consciously added directors and changed board procedures to encourage greater involvement.

Increased involvement is sometimes brought about by crisis. These interviews described boards which per- formed admirably after being suddenly energized by circumstances that threatened their firms’ survival. Board involvement may also increase as a result of negative corporate performance or an unfavourable economy. In such cases, board activity may be motivated, at least in part, by directors’ desire to protect their reputations and personal assets.

These interviews also tell us that directors generally want to be more active than they currently are. If involvement is a function of the amount, quality, and timeliness of the information provided to board members, keeping directors well informed may be the chairman’s most effective means of facilitating directors’ activities. Control of board size was also cited as a factor in involvement: a smaller board tends to increase member activity. Layout of the boardroom and arrange- ment of the board table were also mentioned as factors influencing involvement.

Overall, the impression left by these interviews is that the primary keys to board involvement are whether or not, and to what degree, the chairman wants the board involved, and the information provided to board members.

Board Tenure An interesting aspect of the appointment of directors is the apparent permanence of board seats. Asking a director to step down is a rare occurrence. When it becomes apparent that a director was a bad choice, boards commonly choose to live with their decision until the director’s retirement. How then can, as one director suggested, the mix of board members respond to the company’s immediate situation? Although it is clear that board composition may need to change as a firm’s situation changes, ‘immediate’ adjustments will probably not occur. This calls into question just how effectively boards operating under this type of tradition can uphold their individual and joint responsibilities on behalf of shareholders and other constituents.

Summary As corporate complexity has increased, there have been dramatic increases in delegation and decentralization within firms. These changes have been reflected in an increasingly complex role for boards of directors, yet board structure, composition, selection, and utilization have changed comparatively little. What change we have seen appears to be more the result of reaction and crisis than by strategic design. Mintzberg, et al. (1976) describe a continuum of stimuli that evoke decisions, ranging from opportunity decisions at one extreme to crisis decisions at the other. Opportunity decisions are those initiated on a purely voluntary basis to improve an already secure position. Crisis decisions are made when organizations respond to intense pressures. Changes in boards of directors seem to be more of the crisis than the opportunity variety.

The lack of appropriate board structure and process contributes to the common perception that boards are ineffective. Calls for revitalization of the board as the overseer of corporate responsibility have been increasing, in both frequency and volume. Seldom have these calls, however, been accompanied by realistic suggestions of how such a revitalization might be accomplished.

Although it seems elementary to say that we cannot expect boards to operate effectively today using the same, unquestioned, structure and procedures that were effective fifty, or even twenty years ago, that might be an important starting point for policy discussions. As Table 1 demonstrates, most directors, particularly outside directors, still seem to be selected for their general knowledge rather than for specific capabilities needed by the firm. Why aren’t individual directors selected for the particular unique contributions they can make toward specific corporate needs, based on their individual distinctive competences? This would seem to offer significantly more to board effectiveness than selection of directors based primarily on reputation, stature, social relationships, or other currently-dominant criteria.

Aldrich and Herker (1981) discuss the extent to which



‘boundary roles’ can influence the degree of organizational autonomy through information processing. Those on the boundary of the firm can access valuable information from the environment. With this in mind, the optimal board of any large firm might consist of the minimum number of inside directors necessary to integrate strategic internal and external information, and a majority of carefully-chosen outside directors, selected for their potential as boundary-spanners in particular areas of environmental uncertainty. Boards configured by these means might be appropriately categorized as strategic boards. Their primary roles would include active involvement in evaluating top management performance and in analyzing corporate strategy, as well as advising and counseling top management. Traditional boards, on the other hand, are those whose primary role is perceived as advising and counseling top management.

AS depicted in Figure 1, director selection is potentially one of the key determinants of a board‘s independence, and in its degree of involvement. An independent, involved board is likely to engage in a higher degree of dialectic discussion, leading to inputs to corporate strategy that represent a broader range of perspectives and a wider variety of alternatives. The resulting corporate strategy is likely to be superior to strategy based on narrower perspectives and should contribute more positively to corporate performance.

Although maximization of shareholder wealth remains a primary concern, it has long since ceased being the only concern of board members. Corporate social responsibility in its many forms is now a central issue and becomes more so as a firm grows, thus affecting more constituencies. To ignore the social and cultural effects of its actions jeopardizes not only a firm’s profitability but possibly even its survival. The Community Reinvestment Act (CRA), for example, has had a major influence on the banking industry in the US, by monitoring and controlling how and to whom banks make real estate loans. Multinational corporations are even more vulnerable than domestic firms to the social responsibility concerns of the countries in which they do business.

Strategic selection of directors has, therefore, the potential to make the board of directors a significant force in reducing organizational uncertainty for corporations. The boundary-spanning potential carries dramatic strategic implications. It could make the difference between success and failure of corporations, particularly in the global arena.

This paper argues that the composition of boards of directors has not changed to keep pace with the increasing complexity and increasing need for strategic flexibility in the corporations which boards are charged with overseeing. A tenure system, in which appointment to a board often amounts to a lifetime membership regardless of performance, coupled with a director selection process driven largely by personal

or professional networks, has led to boards that tend to be permanent, complacent, and ingrown.

Implications This article provides important insights into board members’ perceptions of their functions and responsibilities, and of board processes. It opens the door to the boardroom a bit further than before. We have learned more about what directors think are the important issues; the processes of director selection and retention; and, perhaps most important, some light has been shed on the pervasiveness and operation of director networks, and on how they might be more strategically utilized.

If they are to govern effectively it seems logical that boards should be tailored to their individual firms, at least as far as the capabilities they represent. In other words, be more like their own firms than like other boards. Yet, as we have seen, boards seem to be more alike than they are different. It is apparent that tradition and personal relationships play a powerful role in corporate governance.

Keys to improving board effectiveness may be found as researchers seek answers to the following questions:

. How can the processes involved in selection of directors be changed to assure maximization of board effectiveness and involvement?

. How can a director tenure system that guarantees long-term board membership be changed to support a corporate environment that increasingly calls for more organisational flexibility and corporate responsiveness?

. How might networking between directors, boards, and executives be more effectively utilized to help companies achieve strategic objectives?

. To what degree should boards of directors be involved in the formulation of corporate strategies?

Although the list could be extended substantially, these questions seem to strike at the heart of major issues affecting the performance of boards of directors. The answers undoubtedly reside at the source of the questions - the board itself. They will likely be found only by seeking a deeper understanding of boards, through personal interviews and first-hand observations.

Note 1 Mintzberg suggests that a strategy is more than what

a firm intends to do; it also includes what the firm actually does. A firm’s total strategy is, then, the product of whatever intended strategies are actually realized and any (unplanned) strategies that emerge.

References Aldrich, H. and Herker, D., (1981), Boundary Spanning Roles

and Organization Structure, in P.C. Nystrom and W.H. Starbuck (Eds.), Handbook of Orpnizdional Design;



217-230, New York: Oxford University Press. Andrews, K.R., (1979), Appraising Director and Board

Performance Against Rising Standards of Competence and Responsibility, Harvard Business Review, May/June: 46-56.

Andrews, K.R., (1980), Directors’ Responsibility for Corporate Strategy, Harvard Business Review, NovlDec: 30-42.

Andrews, K.R., (1981), Corporate Strategy as a Vital Function of the Board, Harvard Business Review, NovlDec: 174-184.

Andrews, K.R., (1987), The Concept of Corporate Strategy, Homewood, 11: Irwin.

Aram, J.D. and Cowen, S.S., (1986), The Directors’ Role in Planning: What Information do They Need?, Long Range Planning, 19(2): 117-124 (Apr).

Baysinger, B. and Hoskisson, R.E., (1990), The Composition of Boards of Directors and Strategic Control: Effects on Corporate Strategy, Academy of Management Review, 15 (1): 72-87.

Bazerman, M.H. and Schoorman, F.D., (1983), A Limited Rationality Model of Interlocking Directorates, Academy of Management Review, 8(2): 206-217.

Berle, A. and Means, G.C., (1932), The Modern Corporation and Private Property, New York: Macmillan.

Boulton, W.R., (1983), Effective Board Development: Five Areas for Concern, The Journal of Business Strategy, 3(4): 94-100 (Spring).

Burt, R.S., (1983), Corporate Profits and Coopfation, New York: Academic Press.

Cadbury, Sir Adrian, (1992), The Financial Aspects of Corporate Governance, London: Committee on the Financial Aspects of Corporate Governance.

Charkham, JP., (1994), Keeping Good Company, Oxford: Clarendon Press.

Davis, G.F., (1991), Agents Without Principles? The Spread of the Poison Pill Through the Intercorporate Network, Administrative Science Quarterly, 36: 583-613.

Davis, G .F. and Powell, W ., (1992), Organization-Environment Relations, in Marvin Dunnette, (Ed.), Handbook of Industrial and Organizational Psychology, 2nd edition.

Demb, A. and Neubauer, F., (1992), The Corporate Board, New York: Oxford University Press.

Eaton, L., (1990), Corporate Couch Potatoes: The Awful Truth About Boards of Directors, Barron’s, Dec. 24: 22-24.

Fama, E.F. and Jensen, M.C., (1983), Separation of Ownership and Control, Journal of Law and Economics, XXVI: 301-325 (June).

Henke, J. W., Jr., (1986), Involving the Board of Directors in Strategic Planning, The Journal of Business Strategy, 7(2): 87-95 (Fall).

Janis, I.L., (1971), Groupthink, Psychology Today. Jensen, M.C., (1989) Eclipse of the Public Corporation, Harvard

Business Review, SeptlOct: 61-74. Jensen, M.C., (1991), Corporate Control and the Politics of

Finance, Journal of Applied Corporate Finance, Fall: 13-33. Judge, W.Q. and Zeithaml, C.P., (1992), Institutional and

Strategic Choice Perspectives on Board Involvement in the Strategic Decision Process, Academy of Management Journal, 35(4): 766-794.

Lauenstein, M., (1982), The Strategic Side of Dividends, The Journal of Business Strategy, 3(2): 80-82 (Fall).

Lauenstein, M., (1983), To Grow . or Not to Grow ?, The journal of Business Strategy, 4(l): 88-90 (Summer).

Mace, M.L., (1971), Directors; Myth and Reality, Cambridge, Ma: Harvard Business School Classics.

Mintzberg, H., (1978), Patterns in Strategy Formulation, Managerial Science, 24: 934-948.

Mintzberg, H., (1994), The Fall and Rise of Strategic Planning, Harvard Business Review: 107-114 (JanlFeb).

Mintzberg, H., Raisinghani, D. and Theoret, A., (1976), The Structure of ‘Unstructured’ Decision Processes, Administrative Science Quarterly, 21, June: 246-275.

Mob, R., (1985), The Role of the Board of Directors: Typologies of Interaction, The Journal of Business Strategy, 5(4): 86-93.

Monks, R. and Minow, N., (1991), The Directors New Clothes (Or the Myth of Corporate Accountabihty), Journal of Applied Corporate Finance, 4(3): 78-84.

Mueller, R.K., (1979), Criteria for the Appraisal of Directors, Harvard Business Review: 48-49 (May/June).

National Association of Corporate Directors, 2992 Corporate Governance Survey, Feb. 1992.

Penbera, J.J. and Bonner, C., 1990, The Director’s Role in a Takeover Bid, The ]ournal of Business Strategy: 39-42 (May/June).

Pennings, J.M., (1980), Znterlocking Directorates, Washington: Jossey-Bass.

Pfeffer, J., (1972), Size and Composition of Corporate Boards of Directors: The Organization and its Environment, Administrative Science Quarterly, 17: 218-228.

Pinnell, B., (1986), The Role of the Board in Corporate Planning, Long Range Planning, 19(5): 27-32 (Ott).

Porter, M.E., (1980), Competitive Strategy, New York: The Free Press.

Pound, J., (1992), Beyond Takeovers: Politics Comes to Corporate Control, Harvard Business Review, March- April.

Pound, J., (1993), Creating Relationships between Institutional Investors and Corporations: A Proposal to Restore Balance in the American Corporate Governance Process, unpublished paper, Kennedy School of Government, Harvard University.

Rosenstein, J., (1987), Why Don’t U.S. Boards Get More Involved in Strategy?, Lung Range Planning, 20(3): 30-34.

Schoorman, F.D. ., Bazerman, M.H. and Atkin, R.S., (1981), Interlocking Directorates: A Strategy for Reducing Environmental Uncertainty, Academy of Management Review, 6(2): 243-251.

Spradley, J.P., (1979), The Ethnographic Interview, New York: Holt, Rinehart, and Winston.

Tashakori, A. and Boulton, W., 1983, A Look at the Board’s Role in Planning, The Journal of Business Strategy, 3(3): 64-70 (Winter).

Useem, M., (1984), The Inner Circle, New York: Oxford Universitv Press.

Vance, S.C., (1983), Corporate Leadership: Boards of Directors and StratePu. New York: McGraw-Hill.

“_I’

Verespej, M.A., (1994), What’s Next for Directors?, Industry Week, Feb. 21: 11.

Warner, W.L. and Unwalla, D.B., (1967), The System of Interlocking Directorates, in W.L. Warner, (Ed.), The Emergent American Society, Vol. 1, Binghampton, NY: Vail-Ballou Press, Inc.

Williamson, O.E., (1985), The Economic Institutions of Capitalism, New York: The Free Press.

Woods, J.D., (1991), Building a Board for Shareholder Return, Not CEO Tenure, Director’s Monthly, 15(11) (Nov.).

Zahra, S. A. and Pearce, J. A. II, (1989), Boards of Directors and Corporate Financial Performance: A Review and Integrative Model, Journal of Management, 15(2): 291-334.

EUROPEAN MANAGEMENT JOURNAL Vo113 No 1 March 1995 89


DONALD O’NEAL, University of lllinois at Urbana-Champaign, College of Commerce and Business Administration, 260 Commerce West Building, 1206 South Sixth Street, Champaign, 111. 62820-6270, USA.

Donald O’Neal, is Assistant Professor of Management at Sangamon State University

in Illinois. After a successful business career, including management positions in engineering and sales and, latterly, as Vice-President of Human Resources, he studied for a doctorate in strategic management at UIUC. His interests include research in corporate governance, and consulting in the areas of strategy and and leadership.

HOWARD THOMAS, University of Illinois at Urbana-Champaign, College of Commerce and Business Administration, 260 Commerce West Building, 1206 South Sixth Street, Champaign, 111. 61820-6270, USA.

Howard Thomas is Dean of the College of Commerce and Business Administration at the

University of lllinois at Urbana-Champaign, and James F. Towey Professor or Strategic Management at UlUC. He became Dean in May 1992, after serving as lnterim Dean since August 1991. Prior to this he was Foundation Professor of Management at the Australian Graduate School of Management, AGSM, Australia’s National Business School in Sydney, New South Wales, and Director of the Doctoral Programme at London Business School. He is internationally recognized as one of the leading experts in the field of strategic management theory and is President-Elect of

the Strategic Management Society.


Documents

Director networks/director selection: The board's strategic role