The reform of corporate governance from Cadbury (1992) to Higgs (2003) was strongly influenced by agency theory. The reformers’ solution to perceived agency problems in countries with unitary boards was to prescribe rules for board structure, in particular by specifying the number and roles of non-executive directors (NEDs), and requiring the separation of the chairman and CEO functions. In vain did many of us (including eminent academics such as Andrew Pettigrew) point out that it was ‘soft’ issues such as the behaviour of individual directors and their relationships with colleagues that were the major determinants of board performance, and that the prescribed structures could even be destroying shareholder value (Burton 2000). The policy-makers seemed deaf to our entreaties. The structuralists got their way and even Higgs, the most sensitive of the reformers, failed to take on board the full implications of the research he had commissioned for his report (Roberts et al 2005).

Much of the debate has centred on the disruption of board cohesion by the governance structures, particularly by requiring the NEDs to perform a dual role of team member and policeman. (Higgs glided round this point.) But another unfortunate consequence has been boards’ obsession with compliance, rather than with strategy. In a survey of over 200 directors into how they spend their time, Beatty (2004) found directors spent 70% of their time on compliance and routine, and 30% on strategy and talent issues. Board members were reported as saying that these proportions ought to be reversed. You could say that boards’ behaviour reflects the attitude of society to other regulations, such as those for health and safety. In both cases there is fear of being caught up in litigation.

So what has all this rather costly structural regulation brought us? It brought us Enron, Equitable Life, the ‘bonus culture’ and the financial crisis including Northern Rock, and RBS, to name just some of the high-profile disasters, their boards all packed with heavyweight NEDs. Structural regulation has not prevented boards getting derailed, or even failing spectacularly when the going gets really tough. Boards like these are simply not carrying out their responsibilities. It is no exaggeration to say that corporate governance is at a crossroads.

Recent work on employee engagement can help answer this question. There is evidence that passionate, highly engaged employees are associated with superior. company performance (Great Place to Work Institute 2007). It is emerging that this effect applies equally to directors. Boards that are passionate about what they do are also associated with superior performance. It is not hard for NEDs to do some social loafing and withdraw from active participation if they are bored by their agendas. The research originally commissioned by Higgs (Roberts et al 2005) makes the point (not referred to in his report) that the attitude of the executive directors to the NEDs is crucial in determining NED engagement and contribution. If the NEDs are respected, a benign spiral occurs in which NED contribution continually improves. If they are not, the reverse happens, and the NEDs rapidly disengage. It is vital that both types of director understand this.

Copyright Peter Burton 2008 – all rights reserved

References

Burton, P. (2000). Antecedents and Consequences of Corporate Governance Structures. Corporate Governance: An International Review, Vol 8 No 3, 194-203.

Great Place to Work Institute UK (2007). Website: www.greatplacetowork.co.uk

Roberts, J., McNulty, T. and Stiles, P. (2005). Beyond Agency Conceptions of the Work of the Non-Executive Director: Creating Accountability in the Boardroom. British Journal of Management, vol. 16, S5 – S26.