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- Herausgeber: John Wiley & Sons
- Kategorie: Fachliteratur
- Sprache: Englisch
Explore the interplay between corporate governance and strategic decision-making in this startling new resource In Understanding and Managing Strategic Governance, strategy and management experts Dr. Wei Shi and Robert E. Hoskisson deliver an insightful exploration of the influence that governance actors, like the board of directors, activist investors, institutional investors, and securities analysts, have on important strategic decisions. Based on surveying the latest research and analyzing unique datasets compiled by the authors, the book explains the impact that governance actors have on a firm's strategic choices and the quality of such choices as well as the unintended consequences of that impact. The authors also describe how executives can manage the conflicting interests of multiple governance actors and leverage the influence of these actors to make effective strategic decisions. In this book, you'll discover: * How to avoid the strategic pitfalls that arise from governance actor influence and harm firms' long-term competitiveness * The effect that governance actors can have on corporate strategy, competitive strategy, corporate innovation strategy, global strategy, stakeholder strategy, and more * The latest trends in corporate governance and their implications for managers, regulators, and policy makers in this area Perfect for C-level executives, board of directors, and institutional investors as well as students of corporate governance and strategy, Understanding and Managing Strategic Governance is a revealing and original examination of the interplay between corporate governance and firm strategy and how to manage that interplay to create sustainable competitive advantages.
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Veröffentlichungsjahr: 2021
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Table of Contents
Cover
Title Page
Copyright
Dedication
Preface
HOW TO USE THIS BOOK
AUDIENCE AND APPROACH
ACKNOWLEDGMENTS
About the Authors
CHAPTER 1: Introduction to Strategic Governance and Internal Governance Actors
INTERNAL GOVERNANCE
PURPOSES FOR BOARDS OF DIRECTORS
BOARD STRUCTURE AND PROCESS: EFFECTIVE BOARD STRATEGIC CONTROL AND MONITORING
EMPLOYEES AS INTERNAL GOVERNANCE ACTORS
CHAPTER OVERVIEWS
NOTES
CHAPTER 2: Introduction to External Governance Actors
EXTERNAL GOVERNANCE ACTORS WITH DIRECT INFLUENCE AND ALIGNED INTERESTS
EXTERNAL GOVERNANCE ACTORS WITH DIRECT INFLUENCE AND DIFFERING INTERESTS
EXTERNAL GOVERNANCE ACTORS WITH INDIRECT INFLUENCE AND ALIGNED INTERESTS
EXTERNAL GOVERNANCE ACTORS WITH INDIRECT INFLUENCE AND DIFFERING INTERESTS
COPING WITH EXTERNAL GOVERNANCE ACTORS
NOTES
CHAPTER 3: Governance Actors and Corporate Strategy
GOVERNANCE ACTORS AND DIVERSIFICATION STRATEGIES
BOARD MONITORING, EXECUTIVE COMPENSATION, AND DIVERSIFICATION STRATEGY
GOVERNANCE AND STRATEGIC ALLIANCES
GOVERNANCE AND ACQUISITIONS
GOVERNANCE AND DIVESTITURES
OTHER GOVERNANCE ACTORS: PROXY INTERMEDIARIES, FINANCIAL ANALYSTS, AND THE MEDIA
INSTITUTIONAL CHANGE, GOVERNANCE, AND RESTRUCTURING OF DIVERSIFIED BUSINESS GROUPS
SUMMARY OF FIT OR MISFIT BETWEEN MARKET INSTITUTIONS AND CURRENT DIVERSIFICATION STRATEGY
LEVERAGING GOVERNANCE ACTORS TO PURSUE AN EFFECTIVE CORPORATE STRATEGY
NOTES
CHAPTER 4: Governance Actors and Innovation Strategy
INNOVATION STRATEGY
GOVERNANCE ACTORS' INFLUENCE ON INNOVATION
LEVERAGING GOVERNANCE ACTORS TO FOSTER APPROPRIATE INNOVATION STRATEGY
NOTES
CHAPTER 5: Governance Actors and Competitive Strategy
RESOURCE PROVISION AND ENGAGED GOVERNANCE ACTORS
TRANSACTIONAL GOVERNANCE ACTORS THAT PROVIDE RESOURCES
ENGAGED GOVERNANCE ACTORS WITHOUT RESOURCE PROVISION
TRANSACTIONAL GOVERNANCE ACTORS WITHOUT RESOURCE PROVISION
MANAGING GOVERNANCE ACTORS FOR A WINNING COMPETITIVE STRATEGY
NOTES
CHAPTER 6: Governance Actors and Global Strategy
GLOBAL STRATEGY
RESOURCE-PROVISION GOVERNANCE ACTORS WITH LOW RISK TOLERANCE
RESOURCE PROVISION GOVERNANCE ACTORS WITH HIGH RISK TOLERANCE
GOVERNANCE ACTORS WITH LOW RISK TOLERANCE BUT NO RESOURCE PROVISION
GOVERNANCE ACTORS WITH HIGH RISK TOLERANCE BUT NO RESOURCE PROVISION
MANAGING GOVERNANCE ACTORS FOR A WINNING GLOBAL STRATEGY
GOVERNANCE ACTORS AND LEGITIMACY IN GLOBAL STRATEGY
NOTES
CHAPTER 7: Governance Actors and Stakeholder Strategy
STAKEHOLDER STRATEGY
ENGAGED GOVERNANCE ACTORS WITH A STRONG EMPHASIS ON FINANCIAL OBJECTIVES
TRANSACTIONAL GOVERNANCE ACTORS WITH A STRONG EMPHASIS ON FINANCIAL OBJECTIVES
ENGAGED GOVERNANCE ACTORS WITHOUT A STRONG EMPHASIS ON FINANCIAL OBJECTIVES
TRANSACTIONAL GOVERNANCE ACTORS WITHOUT A STRONG EMPHASIS ON FINANCIAL OBJECTIVES
LEVERAGE GOVERNANCE ACTORS TO PURSUE AN EFFECTIVE STAKEHOLDER STRATEGY
PROACTIVE DISCLOSURE AND ENGAGEMENT
RECOMMENDATIONS FOR BOARD MEMBERS
NOTES
CHAPTER 8: Governance Actors and Corporate Political Strategy
CORPORATE POLITICAL STRATEGY
GOVERNANCE ACTORS AND CHOICE OF CORPORATE POLITICAL STRATEGY
MANAGING GOVERNANCE ACTORS TO CREATE POLITICAL ADVANTAGES
NOTES
CHAPTER 9: Strategic Governance in a New Era
CORPORATE GOVERNANCE TRENDS
MANAGING STRATEGIC GOVERNANCE IN A NEW ERA
GOVERNANCE-EXECUTIVE INTERACTION MODEL
NOTES
Index
End User License Agreement
List of Illustrations
Chapter 1
FIGURE 1.1 Understanding and managing the strategic governance challenge.
FIGURE 1.2 Board diversity of S&P 1500 firms.
Chapter 2
FIGURE 2.1 Institutional ownership for S&P 1500 firms (2000–2018).
FIGURE 2.2 Classification of external governance actors.
FIGURE 2.3 Foreign institutional ownership, 2000–2017.
FIGURE 2.4 Average short interest of S&P 1500 firms (1995–2018).
FIGURE 2.5 Response strategies to different external governance actors.
Chapter 3
FIGURE 3.1 Shareholders' and top managers' utility and diversification.
FIGURE 3.2 Shareholders' and top managers' utility and diversification as po...
FIGURE 3.3 Shareholders' and top managers' utility and diversification as ri...
FIGURE 3.4 Average CEO salary and tenure of S&P 1500 firms.
FIGURE 3.5 Costs and diversification.
FIGURE 3.6 Lower transaction costs and diversification.
FIGURE 3.7 Institutional environments and dominant corporate diversification...
FIGURE 3.8 Response strategies to different governance actors.
Chapter 4
FIGURE 4.1 Governance actors and orientation toward innovation.
FIGURE 4.2 Governance actors’ response strategies to foster innovation.
Chapter 5
FIGURE 5.1 Governance actors and competitive strategy.
FIGURE 5.2 Managing governance actors for a winning competitive strategy.
Chapter 6
FIGURE 6.1 Governance actors and global strategy.
FIGURE 6.2 Foreign director ratio of S&P 1500 firms.
FIGURE 6.3 Managing governance actors for a successful global strategy.
Chapter 7
FIGURE 7.1 Different types of stakeholder strategy.
FIGURE 7.2 Governance actors and stakeholder strategy.
FIGURE 7.3 Leveraging governance actors in designing stakeholder strategy.
Chapter 8
FIGURE 8.1 Types of corporate political strategy.
FIGURE 8.2 Governance actors and corporate political strategy.
FIGURE 8.3 Berkshire Hathaway lobbying expenditure.
FIGURE 8.4 Hedge fund political contributions.
FIGURE 8.5 Manage governance actors for a successful corporate political str...
FIGURE 8.6 Number of shareholder proposals on political spending.
Chapter 9
FIGURE 9.1 Number of shareholder activism campaigns targeting US and non-US ...
FIGURE 9.2 Managing strategic governance in a new era.
FIGURE 9.3 Model of governance-executive interactions.
FIGURE 9.4 Recommendations for boards and executives.
Guide
Cover
Table of Contents
Title Page
Copyright
Dedication
Preface
About the Authors
Begin Reading
Index
End User License Agreement
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Understanding and Managing Strategic Governance
WEI SHI
ROBERT E. HOSKISSON
Copyright © 2021 by John Wiley & Sons, Inc. All rights reserved.
Published by John Wiley & Sons, Inc., Hoboken, New Jersey.Published simultaneously in Canada.
No part of this publication may be reproduced, stored in a retrieval system, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording, scanning, or otherwise, except as permitted under Section 107 or 108 of the 1976 United States Copyright Act, without either the prior written permission of the Publisher, or authorization through payment of the appropriate per-copy fee to the Copyright Clearance Center, Inc., 222 Rosewood Drive, Danvers, MA 01923, (978) 750-8400, fax (978) 750-4470, or on the web at www.copyright.com. Requests to the Publisher for permission should be addressed to the Permissions Department, John Wiley & Sons, Inc., 111 River Street, Hoboken, NJ 07030, (201) 748-6011, fax (201) 748-6008, or online at http://www.wiley.com/go/permission.
Limit of Liability/Disclaimer of Warranty: While the publisher and author have used their best efforts in preparing this book, they make no representations or warranties with respect to the accuracy or completeness of the contents of this book and specifically disclaim any implied warranties of merchantability or fitness for a particular purpose. No warranty may be created or extended by sales representatives or written sales materials. The advice and strategies contained herein may not be suitable for your situation. You should consult with a professional where appropriate. Neither the publisher nor author shall be liable for any loss of profit or any other commercial damages, including but not limited to special, incidental, consequential, or other damages.
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Library of Congress Cataloging-in-Publication Data is Available:
Names: Shi, Wei, 1981- author. | Hoskisson, Robert E., 1948-author.
Title: Understanding and managing strategic governance / Wei Shi, Robert Edwin Hoskisson.
Description: First edition. | Hoboken, New Jersey : Wiley, 2021. | Includes index.
Identifiers: LCCN 2021022872 (print) | LCCN 2021022873 (ebook) | ISBN 9781119798255 (cloth) | ISBN 9781119798309 (adobe pdf) | ISBN 9781119798286 (epub)
Subjects: LCSH: Corporate governance. | Decision making. | Strategic planning. | Information technology—Management.
Classification: LCC HD2741 .S4985 2021 (print) | LCC HD2741 (ebook) | DDC 658.4—dc23
LC record available at https://lccn.loc.gov/2021022872
LC ebook record available at https://lccn.loc.gov/2021022873
Cover Design: WileyCover Image: © Sergey Mironov\shutterstock
The book is dedicated to our parents, Xiangsheng Shi, Shimei Hui, Claude W. Hoskisson, and Carol B. Hoskisson, for their constant love and support.
Preface
Corporate executives are responsible for making a myriad of strategic decisions that shape a firm's competitiveness and performance. Yet, executives' strategic choices are constrained by governance actors, such as the board of directors or institutional investors, who can directly or indirectly influence corporate decisions. Although much has been written about corporate governance, there is no systematic analysis of how governance actors can influence strategic decisions. A company's strategic decisions such as R&D investment and business expansion determine its competitive position and ability to care for its stakeholders. Meanwhile, governance actors can influence these important decisions through deliberate involvement but also through unintentional means. Thus, understanding and managing how governance actors shape strategic decisions is crucial to both corporate executives and governance actors.
This book explains the impact of governance actors on strategic decisions, which is referred to as strategic governance, and provides suggestions on how corporate executives can leverage governance actors to make effective strategic decisions. To facilitate our discussion, we classify governance actors into internal and external governance actors and analyze their respective influences on a myriad of strategic decisions, including corporate strategy, competitive strategy, global strategy, innovation strategy, stakeholder strategy, and corporate political strategy. Internal governance actors refer to governance actors who have direct employment relationships with a firm and include the board of directors, peer executives, and employees. In contrast, external governance actors are those who do not have direct employment relationships with a firm and consist of investors, customers, suppliers, and external information intermediaries, such as financial analysts, rating agencies, and government regulators.
HOW TO USE THIS BOOK
The book is organized as follows. Chapters 1 and 2 introduce internal governance actors and external governance actors and discuss the channels through which they can play a governance role and influence executive decisions. From Chapters 3 to 8, we explain the influence of internal and external governance actors on a given specific strategy. We also provide our recommendations on how corporate executives can manage their relationships with governance actors to design effective strategies. In Chapter 9, we offer our evaluation of new trends in the governance landscape and our recommendations on how corporate executives and governance actors can work together to navigate these trends successfully.
In formulating each chapter, we carefully studied the most recent academic research to ensure that the content about strategic governance is up to date and accurate, as evidenced by the detailed endnotes for each chapter. In addition, we continuously read articles appearing in many different business publications (e.g., Wall Street Journal, Bloomberg Businessweek, Fortune, Financial Times, Fast Company, Forbes, and Harvard Business Review, to name a few). By studying a wide array of sources, we have identified valuable examples of how companies across the world are affected by governance actors and their consequences on managerial strategic decisions.
Each chapter begins with a boxed example labeled Strategic Governance Challenge, and there are breakout examples within the body of each chapter (labeled Strategic Governance Highlight) to illustrate critical governance issues of concern or provide more in-depth understanding of critical strategic issues resulting from governance activities in each chapter.
Although the book is written so that it can be read from cover to cover, each chapter also stands on its own. Readers can select and read the chapters most relevant to their interests (corporate strategy, competitive strategy, innovation strategy, global strategy, and so on).
AUDIENCE AND APPROACH
The book will be suitable for three groups of readers. First, corporate executives who directly get involved in making strategic decisions may find it interesting to learn how governance actors can affect their decisions. Managerial guidance provided by the book can help them capitalize on governance actors to make effective, viable strategic decisions. Second, governance actors such as board members and institutional investors may find the book valuable. This book will devote much attention to revealing some unintended consequences of governance actors on strategic choices, which is critical for governance actors to avoid or alleviate their negative implications. Third, this book covers a comprehensive list of topics at the interface of strategy and corporate governance. In this sense, it can benefit a general audience that seeks to understand the role of corporate governance in critical strategic decisions. Likewise, it might be useful as a textbook for strategic management or corporate governance courses. In particular, the book is apropos for board of director training, graduate university courses, and executive education programs.
To maximize your opportunities to understand as you read and think about how actual companies are managing the strategic governance challenges, we emphasize a lively and user-friendly writing style. Collectively, no other book on corporate governance presents you with the understanding of how salient current corporate governance trends are affecting major strategic decisions using a combination of useful and insightful research and applications in a variety of local and global companies as does this book. We provide managerial guidance on leveraging governance actors and managing conflicting interests to achieve sustainable competitive advantages. The interests of governance actors are often not aligned with each other in the short term, and governance actors may impose conflicting demands on corporate executives. Therefore, it is important for executives to understand and manage such conflicting demands and avoid strategic pitfalls that can harm a firm's long-term competitiveness. Thus, no other book provides managerial suggestions to facilitate ways of dealing with the salient governance issues of the day for both top managers as well as involved governance actors.
We believe that this book not only helps corporate executives and governance practitioners better understand their roles in shaping firm strategic decisions and how they can leverage governance actors to make more effective strategic decisions but it also offers an overview for a general audience to understand the current trends in corporate governance and how they influence key strategic decisions on which corporate executives and governance actors must accommodate each other to implement such decisions.
ACKNOWLEDGMENTS
We would like to thank Sheck Cho of Wiley for his belief in our work, and we appreciate the financial support of Miami Hebert Business School, University of Miami, and Jones Graduate School of Business, Rice University. In addition, we would like to thank Haicao Zhu and Kim Kijong for their research assistance and Cibeles Duran for her careful copyediting of the entire book. We would also like to thank Claudia Kolker for her feedback on the book's introduction.
We would like to acknowledge the many collaborators and colleagues who have made this book possible. Although many other sources are cited in the book, our direct collaborators whose work is described or reflected in the book include: Ruth Aguilera, Jay Barney, Berry Baysinger, Juan Bu, Lowell Busentiz, Bert Cannella, Guoli Chen, Tao Chen, Shih-Chi (Sana) Chiu, Kubilay Cirik, Brian Connelly, Marie Dasborough, Parthiban David, Mark DesJardine, Fabrizio Ferri, Igor Filatotchev, Eni Gambeta, Orhun Guldiken, Abhinav Gupta, Cheng Gao, Javier Gimeno, Colby Green, Wayne Grossman, Jeff Harrison, Matt Hersel, Charles Hill, Mike Hitt, Duane Ireland, Fuxiu Jiang, Jing Jin, Richard Johnson, Dave Ketchen, Heechun Kim, Hicheon Kim, Dave King, Balaji Koka, Kang Lee, Haiyang Li, Jiangyan Li, Qiang (John) Li, Toby Li, Yu Li, Yadong Luo, Gerry McNamara, Philipp Meyer-Doyle, Doug Moesel, Herman Ndofor, Seemantini Pathak, Gerry Sanders, Doug Schuler, Laszlo Tihanyi, Tom Turk, Kevin Veenstra, Jack Walker, Bill Wan, Kai Wang, Jim Westphal, Mike Wright, Chongwu Xia, Xiwei Yi, Daphne Yiu, Anthea Zhang, Xiaojia Zheng, Zhihui Sun, and Daniel Zyung among others.
About the Authors
Wei Shi is an associate professor of management and Cesarano Faculty Scholar at Miami Herbert Business School, University of Miami. He obtained his MBA from Tulane University and PhD in business administration from Rice University. His primary research interest focuses on the influence of corporate governance actors and upper echelons on strategic decisions. He has taught courses in strategic management, corporate governance and organization, and corporate governance. His research has been published at outlets such as Academy of Management Journal, Strategic Management Journal, Organization Science, Journal of Management, and Journal of Corporate Finance, and covered by Harvard Business Review and theWall Street Journal. He is a senior editor of Corporate Governance: An International Review and sits on the editorial boards of multiple journals, including Strategic Management Journal, Organization Science, Journal of Management, and Global Strategy Journal. He currently serves as a board member of International Corporate Governance Society and a representative-at-large for Strategic Leadership and Governance Interest Group of Strategic Management Society.
Robert E. Hoskisson is the George R. Brown Emeritus Chair of Strategic Management at the Jesse H. Jones Graduate School of Business, Rice University. He received his PhD from the University of California–Irvine. His research topics focus on corporate governance, acquisitions and divestitures, corporate and international diversification, and cooperative strategy. He has taught courses in corporate and international strategic management, cooperative strategy, and strategy consulting. He has co-authored over 30 books, including recent books on business strategy and competitive advantage. Dr. Hoskisson has served on several editorial boards for such publications as the Strategic Management Journal (associate editor), Academy of Management Journal (consulting editor), Journal of International Business Studies (consulting editor), Journal of Management (associate editor), and Organization Science. His research has appeared in over 130 publications, including the Strategic Management Journal, Academy of Management Journal, Academy of Management Review, Organization Science, Journal of Management, Academy of Management Perspective, Academy of Management Executive, Journal of Management Studies, Journal of International Business Studies, Journal of Business Venturing, Entrepreneurship Theory and Practice, California Management Review, and Journal of World Business. Dr. Hoskisson is a fellow of the Academy of Management and also a fellow of the Strategic Management Society. He was a representative-at-large on the board of governors of the Academy of Management for three years. He also served as president of the Strategic Management Society and served on its executive committee for 6 years and on its board of directors for a total of 12 years.
CHAPTER 1Introduction to Strategic Governance and Internal Governance Actors
BOX 1.1 Strategic Governance Challenge: Chaos in the Board Room
According to a recent survey of 341 chief marketing officers, chief marketing officers (CMOs) spend 68.5 percent of their time “managing the present” and only 31.5 percent “preparing for the future.” The survey took place before the COVID-19 pandemic, making it especially telling since strategic marketing is meant to focus on developing initiatives that help build future competitiveness. This type of short-termism, research suggests, has been a rising trend among top management teams for decades. Executives, after all, must increasingly contend with pressures from performance-oriented governance actors such as activist shareholders when making strategic decisions. Some researchers, however, do not consider this trend problematic, asserting that company executives must manage firms for long-term value creation and short-term performance. Under this view, corporate leaders who avoid these twin imperatives do so at their peril.
While boards of directors are duly bound to act with care and loyalty and without conflicting interests for the benefit of shareholders, activist owners among the shareholders pursue returns without necessarily regarding long-term strategic visions, often playing a powerful role in short-termism.
One recommendation for short-termism includes “reward long-term investors” by creating more tiers for tax breaks for long-term investors because the current taxing system rewards trading securities rather than owning companies for the long term. Board members may also align executive compensation with long-term results to motivate them to carry out visions for the long run. These proposals typically try to address governance challenges due to activist shareholders steadily gaining influence on corporate strategic decisions, often forcing election of their board candidates to provide direct inputs into major strategic decisions.
In March 2020, for example, activist hedge fund Impala Asset Management LLC filed documents nominating two directors to Harley-Davidson's board. Impala investors also called for replacing then-CEO Matthew Levatich, who had shifted the firm's marketing focus to a more diverse customer base with Harley's “More Roads” campaign, away from its traditional base of 35- to 60-year-old Americans who buy expensive motorcycles. While Harley holds approximately 50 percent of the US market share in this segment, in recent years the company had been losing sales to bikes produced by BMW, Ducati, and Triumph. According to Impala, the management change was “needed because the current board wasn't proactive enough to address the poor performance,” noting that, in 2019, Harley Davidson underperformed its peers and missed its unit shipping guidance for a fifth year in a row, even while Levatich's pay had been raised to more than $11 million, a figure higher than any he had been paid since taking over in 2015. In February 2020, a new CEO, Jochen Zeitz, was abruptly put in place due in part to the pressure of Impala as Levatich stepped down, and Zeitz is refocusing Harley on its traditional business.
In addition to pressuring for reshuffled management, activist shareholders may also use what are known as “wolf pack” strategies. Hedge fund activists team up to foster a common agenda, often forcing firm leaders to boost short-term performance at the expense of the interests of long-term investors and other stakeholders. Such pressures have a compounding effect. One director notes: “From dealing with multiple crises, to being sued, to orchestrating spinoffs, buyouts, and mergers, to dealing with activists, these all bring their own set of challenges.” The director makes the point that tough issues, once outlier events, have become commonplace as company leaders come under an increasingly “hot spotlight” from multiple stakeholders, forcing directors to answer more quickly and proactively.
We have written this book to enable practitioners to navigate the new, ever-more challenging governance environment. Managers and board members urgently need up-to-date, sophisticated comprehension on what we call strategic governance: the tools and orientation to fully understand and then manage the increasingly chaotic world of corporate governance and strategic decision-making.
Sources: Campbell, P. (2020). Managing tough issues in the boardroom. https://boardmember.com/managing-tough-issues-in-the-boardroom/, accessed July 13, 2020; Coppola, G., & Weiss, R. (2020). Harley-Davidson gets an unlikely rider. Bloomberg Businessweek, July 27, 8–10; Sampson, R. C., & Shi, Y. (2020). Are US firms becoming more short-term oriented? Evidence of shifting firm time horizons from implied discount rates, 1980–2013, Strategic Management Journal, forthcoming; Welch, D., Deveau, S., & Coppola, G. (2020). Activist battling Harley's board urges focus on core riders. Bloomberg, www.bloomberg.com, March 20; Christie, A. L. (2019). The new hedge fund activism: Activist directors and the market for corporate quasi-control. Journal of Corporate Law Studies 19 (1): 1–41; Moorman, C., & Kirby, L. (2019). How marketers can overcome short-termism. Harvard Business Review Digital Articles, www.hbs.com, 2–5; Thomas, L. (2019). Stop panicking about corporate short-termism. Harvard Business Review Digital Articles, www.hbs.com, 2–4; Porter, M.E. (1992). Capital disadvantage: America's failing capital investment system. Harvard Business Review 70 (5): 65–82.
How many corporate governance teams are equipped to face the strategic challenges spurred by the cross currents within the contemporary activist environment? Authentic strategic governance must go beyond simply making a set of decisions in response to a specific issue, and move toward a comprehensive approach for dealing with activist governance actors. Although activists are mostly found outside the firm, more are working from the inside upon the election of activist representative board members. As activist governance players proliferate and refine new techniques (as those described in the Strategic Governance Challenge Box 1.1), top executives and boards of directors must make critical strategic decisions, often under conflicting pressures. Top managers face the difficulty of needing to move the company forward while managing the challenges to their leadership from outside stakeholders, many of whom hold leverage over firm ownership voting rights, wield power to marshal governance advocates, and exert influence over the views of journalists and analysts.
The Harley-Davidson case that opens this chapter stands as a powerful example of how activist shareholders, the primary initiators of activist campaigns, often try to gain control of a company or replace management. But the activist may force major corporate change through other ways, such as by demanding divestitures and selloffs.1 Announcements to sway the strategic decision-making of a board and CEO have significant influence on stock prices.2 Activist announcements often impact stock market analysts' views, prompting changes in analysts' buy or sell recommendations, which may influence a firm to change its strategy.3
Generally, hedge funds and activist pension funds originate this kind of activism. But, as we will see in our book, other corporations also engage in external governance campaigns through hostile takeover attempts for corporate control or by buying noncontrolling block ownership. Even shareholder governance watchdogs, such as the Institutional Shareholder Services (ISS) and Glass Lewis, as well as government regulators such as the Securities and Exchange Commission, may take actions that demand a strategic response. To manage these types of external governance actors, a firm's internal governance team needs to understand how to best interact with these actors and how to make strategic decisions that will respond to or counteract their targeting, while at the same time capitalizing on the expertise and experiences that these external influencers provide. Boards and managers must also prepare to handle legal interventions, as activist shareholders increasingly turn to the courts in efforts to maintain shareholder rights and value. Responding to these actions is proving expensive; the price of director and officer (D&O) insurance, for example, rose by 104 percent in the United States in the first quarter of 2020 compared with the same period a year earlier. The price rose by 255 percent for the same timeframe in Australia.4
The board of directors serves as a firm's central internal governance mechanism. Directors monitor management, provide advice on major strategic decisions, and direct employment relationships especially by selecting top executives and establishing executive compensation structures. Meanwhile, owners, especially institutional owners, are the main external governance mechanism for publicly traded firms. Historically, top executives have largely held control over major strategic decisions as boards only symbolically monitor, providing merely a “rubber stamp” on the critical strategic decisions.5 Although this tendency continues, especially in countries with large family-controlled diversified business groups like in India and many Asian (South Korea, Japan, Taiwan) and Latin American countries,6 change is occurring quite drastically in Western countries, especially in the United States and United Kingdom. Activist investors, who exercise their voice about strategic decisions and executive compensation, drive the change. Their central approach consists of buying significant stakes of shares to seek control of firms or to use the proxy voting system to place activist investor representatives on boards of directors of targeted firms. Activists lobby corporations for corporate governance changes along with proxy intermediaries and governance watchdogs such as ISS and Glass Lewis. Government policy and associated agencies have also fostered more shareholder power and transparency through increased regulation as with the Sarbanes-Oxley (SOX) and Dodd-Frank Acts. These combined forces have increased the potency of shareholder activism, especially when other institutional investors (even index focused institutional investors) follow the lead of the activists.7
Although the activism noted above has caused turmoil among firms' board members and top management teams, the practice has created more intense governance and has given more voice to shareholders on strategy issues. For instance, activists have pursued more long-term compensation packages, which has created pressure for improved performance. Yet the greatly added pressure to perform has led some firm leaders to “cook the books,” contributing to more financial fraud.8 Another indirect effect of activism impacts areas such as supply chains and market power, such as when a firm targeted by activists causes pressure on suppliers, especially those heavily dependent on the target for a large portion of their sales, to reduce costs.9
These increasing and sometimes severe impacts of shareholder activism explain the burgeoning number of academic treatises on corporate governance, usually defined as a set of mechanisms used to manage stakeholder relationships, establish rules to determine and control enterprise strategic decision-making, and distribute the returns from investments.10 At its core, corporate governance seeks to help ensure effective strategic decisions, facilitate the firm's strategic goals, and foster stakeholders' cooperation to achieve those goals. However, though the goals may be straightforward, the practice can prove difficult because of the many potentially conflicting interests of the various stakeholders.
Although substantial research examines the impact of these influences on governance outcomes, such as executive compensation,11 less focus occurs on the effects that governance actors have on the various areas of organizational development, including corporate strategy (such as acquisitions and divestitures), competitive strategy, global expansion, and stakeholder policies like more socially responsible and nonmarket investments. We aim to provide strategic governance recommendations and direction for executives as well as board members to understand antecedents that trigger interaction between firm executives and activist governance actors, what the consequences of responses might be, and possible strategic actions that firm executives and governance actors might take under specific strategic governance situations. Such guidance might become particularly important when conflicting influences arise among executives, board members, and outside governance stakeholders during key strategic decisions. We lay out the organization of our book in Figure 1.1. Our discussion of internal governance mechanisms in this chapter will proceed to an exploration of external governance mechanisms in Chapter 2, followed by an examination of the direct effects of governance actors in the following chapters on specific strategies and strategic decision-making and the indirect effects on other stakeholders, including competitors, suppliers, and customers, while tracking the impact on focal firm performance and shareholder returns.
FIGURE 1.1 Understanding and managing the strategic governance challenge.
INTERNAL GOVERNANCE
Although corporate executives are responsible for making a myriad of strategic decisions that contribute to a firm's competitiveness and performance, their choices are constrained by internal corporate governance actors such as the board of directors and employees. While much has been written about internal governance, especially about boards, no systematic analysis exists on how internal governance actors influence strategic decisions. We examine relatively unchartered territory by examining the actors' impacts on decision-making, beginning with an analysis of the different board attributes and tools that directors use to govern firm executives and shape decisions. Our discussion will include a look at how employees, as another important internal stakeholder, can also shape corporate governance and strategic decisions.
Corporate governance, though more challenging than in the past, is critical to firm success. Under its scope, directors make the vital decision of selecting an appropriate CEO to guide the strategic direction of the firm. If the board makes an unwise choice, not only in selecting but also in setting the compensation of the strategic leader, shareholders and stakeholders all suffer. As such, effective leadership succession plans and appropriate monitoring and direction-setting efforts by the board of directors contribute positively to a firm's performance. Boards face unforeseen circumstances, as in the need to replace a CEO due to financial misconduct. In this case, research shows that directors tend to choose a successor with a degree from a religious university, since such a choice has been shown to reduce the likelihood of misconduct.12 Similarly, when KPMG, one of the big four accounting firms, was questioned by the Internal Revenue Service and found culpable of engaging in inappropriate tax shelters for years in the late 1990s and early 2000s, the directors of the company hired a new CEO, appointed a former judge onto its board, and established board committees focused on fostering better professional ethics and risk compliance norms through its operations committee. Likewise, they pursued vigorous ethics and risk training for all employees.13 Their efforts saved KPMG from suffering a fate similar to Arthur Andersen, a former “Big Five” accounting firm that ceased to operate due to the Enron fiasco.
In addition, choosing an outside versus an inside CEO (one who is currently employed at the firm) can lead to more strategic risk taking for the organization, but such increased risk taking can result in performance extremeness.14 Increased strategic risk taking is analogous to swinging for the fence in baseball (trying to hit a home run). Although Babe Ruth set home run records, he also set record strikeouts at the plate. Appropriate executive compensation also influences risk taking. Too much emphasis on CEO stock options leads to excessive strategic risk taking and can lead to some good performance, though poor performance (striking out) is more likely.15
PURPOSES FOR BOARDS OF DIRECTORS
A board of directors is a group of individuals elected by shareholders whose primary responsibility is to act in the best interests of stakeholders, particularly owners, by formally monitoring and controlling the firm's top-level managers. Board members reach their expected objectives by using their powers to set strategies and policies for the organization and reward and discipline top managers. The work of boards, though important to all shareholders, becomes especially important to a firm's individual shareholders with small ownership percentages since they depend heavily on the directors to represent their interests.
Unfortunately, evidence suggests that boards have not been highly effective in monitoring and controlling top-level managers' decisions and subsequent actions.16 This problematic conclusion may be even more prevalent in emerging-market countries. However, large differences exist in the arrangement of governance systems between developed and emerging markets around the world. The Strategic Governance Highlight (Box 1.2) provides an illustration of how boards conduct strategic governance in Europe, Japan, and China. Although insider-dominated boards still prevail in much of the world, the trend is changing, especially in developed countries like Germany and Japan, but also in emerging market countries like China.
As noted earlier, among emerging countries and historically in the United States, inside managers dominate boards of directors. Yet, we concur with the widely accepted view that a board with a significant percentage of its membership composed of the firm's top-level managers provides relatively weak monitoring and control of managerial decisions. Under such a board, managers sometimes use their power to select and compensate directors and exploit their personal ties to implement strategies that favor executive interests. In 1984, in response to this concern, the New York Stock Exchange (NYSE) implemented a rule requiring outside directors to head the audit committee. Subsequently, after the SOX Act was passed in 2002, other new rules required that independent outside directors lead important committees, such as the audit, compensation, and nominating and governance committees. Policies of the NYSE now require companies to maintain boards of directors that are composed of a majority of outside independent directors, as well as to maintain fully independent audit committees.
But while the additional scrutiny of corporate governance practices has led boards to devote significant attention to recruiting quality independent directors,17 the emphasis on outside directors has led to 40 percent of boards having only one inside manager on the board: the CEO. This scenario produces another less-than-ideal dynamic that leads to less monitoring of executive decisions by the board,18 since monitoring becomes more focused on financial control rather than strategic control, especially without sufficient insider managers to properly inform the outside members about the intricacies of long-term strategic decisions and how they are implemented.19 In fact, such boards (with the CEO as the only insider) pay the chief executive excessively, have more instances of financial misconduct, and have lower performance than boards with more than one insider.20 Boards should seek balance to be sufficiently knowledgeable and achieve the most effective approach to fulfilling their purpose over time in representing stakeholder interests. Next, we take a closer look at board characteristics, monitoring, and setting executive compensation to further understand strategic governance.
BOX 1.2 Strategic Governance Highlight: Boards in Europe, Japan, and China
Corporate governance is of concern to individual firms as well as nations. Although corporate governance reflects company standards, it also collectively reflects the societal standards of countries. Standards are changing, even in emerging economies, such as in the level of independence of board members to enact practices for effective oversight of a firm's internal control efforts. Since firm leaders seek to invest in countries with national governance standards that are acceptable to them, especially when expanding geographically into emerging markets, national governments pay attention to corporate governance.
German firms with more than 2,000 employees are required to have a two-tiered board structure that places the responsibility of monitoring and controlling managerial (or supervisory) decisions and actions in the hands of a separate group. All the functions of strategy and management are the responsibility of the management board. However, appointment to management falls under the responsibility of the supervisory tier, while employees, union members, and shareholders appoint members to this supervisory tier. Proponents of the German structure suggest that it helps prevent corporate wrongdoing and rash decisions by “dictatorial CEOs,” making the board more stakeholder- versus shareholder-dominant. However, critics maintain that the structure slows decision-making and often ties a CEO's hands during strategy development and implementation. The corporate governance practices in Germany makes it difficult to restructure companies as quickly as in the US. Also, because of the role of local government (through the board structure) and the power of banks in Germany's corporate governance structure, private shareholders rarely have major ownership positions in German firms.
As in Germany, banks in Japan have an important role in financing and monitoring large public firms. Because the main bank in a keiretsu (a group of firms tied together by cross-shareholdings) owns a large share position and holds a large amount of corporate debt, it has the closest relationship with a firm's top-level managers. The main bank managers provide financial advice to firm leaders and also closely monitor managers, although they have become less significant in fostering corporate restructuring. Japanese firms are also concerned with a broader set of stakeholders than are firms in the US, including employees, suppliers, and customers, because of their group ties. Moreover, a keiretsu is more than an economic concept—it, too, is a family-like network. Some believe, though, that extensive cross-shareholdings impede the type of structural change that is needed to improve the nation's corporate governance practices. However, recent changes in the governance code in Japan have been fostering better opportunities for improved shareholder monitoring.
China has a unique and large economy, mixed with both socialist and market-oriented traits. Over time, the government has done much to improve the corporate governance of listed companies, particularly in light of increasing privatization of businesses and the development of equity markets. However, the stock markets in China remain young and in development. In their early years, these markets were weak because of significant insider trading, but with stronger governance, they have improved. There has been a gradual decline in the equity held in state-owned enterprises while the number and percentage of private firms have grown, but the state still relies on direct and/or indirect controls to influence the strategies that firms employ. Even private firms try to develop political ties with government officials because of their role in providing access to resources and to the economy. Political governance—control mechanisms used by political actors to achieve their political objectives—permeates listed firms in China. In fact, oftentimes political governance supersedes corporate governance. At times, executives and boards must satisfy government-mandated social goals above maximizing shareholder returns. Such a model sets up potential conflicts between the owners, particularly between the state owner and the private equity owners of such enterprises.
Along with changes in the governance systems of specific countries, multinational companies' boards and managers also evolve (see Chapter 6). For example, firms that have entered more international markets are likely to have more top executives with greater international experience and to have a larger proportion of foreign owners and foreign directors on their boards. These encounters tend to shift governance systems toward more stakeholder-oriented systems in the United States and more shareholder-oriented systems in Europe and China and other emerging market countries.
Sources: Shi, W., Aguilera, R., & Wang. K. (2020). State ownership and securities fraud: A political governance perspective. Corporate Governance: An International Review 28 (2): 157–176; Aguilera, R. V., Valentina, M., & Ilir, H. (2019). International corporate governance: A review and opportunities for future research. Journal of International Business Studies 50 (4): 457–498; Oehmichen, J. (2018). East meets West—corporate governance in Asian emerging markets: A literature review and research agenda, International Business Review 27: 465–480; Foley, S. (2017). The battle of the US corporate governance codes, Financial Times,www.ft.com, February 5; Soltani, B., & Maupetit, C. (2015). Importance of core values of ethics, integrity and accountability in the European corporate governance codes, Journal of Management & Governance 19: 259–284; Aguilera, R. V., Judge, W. Q., & Terjesen, S. A. (2018). Corporate governance deviance, Academy of Management Review 43: 87–109; Chie, A., & Giovanni, G. (2017). Unstash the cash! Corporate governance reform in Japan, Journal of Banking & Financial Economics 37: 51–69; Lai, L., & Tam, H. (2017). Corporate governance, ownership structure and managing earnings to meet critical thresholds among Chinese listed firms, Review of Quantitative Finance & Accounting 48: 789–818; Du, X., Jian, W., & Lai, S. (2017). Do foreign directors mitigate earnings management? Evidence from China, International Journal of Accounting 52: 142–177; Lincoln, J. R., Guillot, D., & Sargent, M. (2017). Business groups, networks, and embeddedness: Innovation and implementation alliances in Japanese electronics, 1985–1998, Industrial & Corporate Change 26: 357–378; Schuler, D., Shi, W., Hoskisson, R. E., & Chen, T. (2016). ‘Windfalls of emperors' sojourns: Stock market reactions to Chinese firms hosting high ranking government officials. Strategic Management Journal 38 (8): 1668–1687; Berkman, H., Cole, R. A., & Fu, L. J. (2014). Improving corporate governance where the state is the controlling block holder: Evidence from China, European Journal of Finance 20: 752–777; Kosaku, N. (2014). Japan seeks to lure investors with improved corporate governance, Wall Street Journal, www.wsj.com, June 28; Li, J., & Qian, C. (2013). Principal-principal conflicts under weak institutions: A study of corporate takeovers in China, Strategic Management Journal 34: 498–508; Fiss, C., & Zajac, E.J. (2004). The diffusion of ideas over contested terrain: The (non)adoption of a shareholder value orientation among German firms, Administrative Science Quarterly 49: 501–534.
BOARD STRUCTURE AND PROCESS: EFFECTIVE BOARD STRATEGIC CONTROL AND MONITORING
Mainly driven by the argument under agency theory that top managers have too much power and thereby use the firm for better perquisites (such as compensation), board members abide by an institutional norm holding that governance should be focused on control and overcoming potential managerial malfeasance, which is often labeled as the audit culture.21 Too focused on auditing, board members may not sufficiently emphasize the need for stewardship and providing strategic advice. As boards are primarily formed to oversee the decision-making processes of corporations, while CEOs and the top management teams are in charge of decision management,22 strategic governance should center on better use of the human and social capital of board members to improve, and not just watch over, strategic decision-making.23
Because of the audit culture found on many boards, outside directors have not been used fully to contribute to strategic decision-making. However, outside board members can help shape the content, context, and conduct of strategy formulation.24 According to a survey by Russell Reynolds Associates,25 boards of companies that exceeded total shareholder return (TSR) compared to relevant benchmarks for two or more years in a row spend more time on forward-looking, value-creating activities such as strategic planning and review and oversight on major strategic transactions, and less time on audit or compliance activities than their fellow directors on other boards. As a result, “the emphasis on board independence and control may hinder the board contribution to the strategic decision-making.”26
Board Chair
To facilitate better strategic governance, we examine the relationship between the board chair and the chief executive officer. As mentioned, the audit culture prompted by agency theory27 creates a relationship between a CEO and a control-oriented chair marked by distance and authority. This relationship does not always need to be solely control-oriented and can have a collaborative approach in which the board chair provides strategic advice. For example, when Hewlett-Packard split into two companies, Meg Whitman became CEO of Hewlett-Packard, Inc., and at the same time board chair of Hewlett-Packard Enterprise. She said in a CNBC interview: “I know the role of the chairman, and I know how it is different than the role of the CEO. The chairman is not there to run the company. The chairman [role] is to help the board be productive, help the CEO be successful.” As Whitman suggests, the chairman may play a supportive role to the CEO, providing a close source of advice and guidance.28 Also, separating the CEO and chair roles (as opposed to cases in which the CEO is also the chair), as Whitman did, may enhance CEO–board collaboration by reducing the demands on the chief executive's time, allowing the CEO to specialize in managing the firm's strategy and operations.
Although many firms still assign the chairman position to the CEO to provide a unitary authority structure,29 some scholars under the agency theory advocate for separate roles to provide better control of management.30 Having the positions as separate roles with a collaborative board chair can provide both improved strategy and better board leadership. Research supports this conclusion, finding that board chairs can provide significant value (up to 9 percent improved firm performance) through advice and counsel, legitimacy, information linkages, and preferential access to external commitments and support.31 This approach proves particularly beneficial when firms face fast-changing external environments such as in high technology firms. In essence, by providing improved strategic governance, board chairs can add significantly to firm value.
Board Committees
Board members who chair key board committees can also add to firm value through their approach to strategic governance.32 In fact, the importance of board committees has grown over time due to increased legal requirements and the growing complexity of the business environment.33 Research tells us about the overall board structure or board member demographics, such as functional backgrounds and ages, but not so much about the detailed work of directors that mostly occurs in committees. In particular, all boards, especially in Western cultures, have committees that identify new board members and facilitate CEO search processes (nominating and governance committees), set executive compensation (compensation committee), and oversee financial reporting (audit committee). These three dominant committees are today required by public stock exchanges and the SOX Act. The SOX Act additionally requires that they be headed by independent outside directors—those that are not inside managers and have no stakeholder affiliation (such as legal representation or customer or supplier relationship). The three committees, part of the audit culture, function to protect shareholders and other stakeholders from managerial malfeasance. Managers should not have the power to nominate board members that supervise their decisions, set their own compensation, or make aggressive or fraudulent accounting decisions.
In theory, shareholders appoint directors. In practice, however, shareholders simply ratify director candidates selected by the board's nominating committee, although the proxy voting process has become increasingly complex due to activist discontent.34 As described in more detail in the Strategic Governance Highlight (Box 1.3), activist board members are elected to targeted boards and often represent wolf pack hedge funds who have teamed together. These board members push for share price increases and other activist agenda items, which may come at the expense of other stakeholders. The nomination process is hence critical in making appropriate director appointments, as the effectiveness of the board with regard to its monitoring role depends on the quality of the board members selected.35
BOX 1.3 Strategic Governance Highlight: How Did Boards Become More Activist-Oriented?
The 1980s was known for hostile takeovers and the use of junk bonds to facilitate large takeovers by corporate raiders. This period inspired a book and movie titled Barbarians at the Gate, which chronicles the takeover by Kolberg, Kravis, and Roberts (KKR) of RJR Nabisco in a stunning $24 billion deal. However, in the early 1990s, the market for corporate control became dampened after the collapse of the junk bond market and the jailing of Michael Milken and the failure of his firm, Drexel Burnham Lambert.
In the late 1990s, institutional investors, such as pension funds and mutual funds, became more active. Although institutional investor activism rose in this period, the market for corporate control declined because of defensive actions by boards that largely insulated firms from pressure. But activist hedge funds stepped in with more offensive actions. In the 2000s, activist hedge funds began to nominate unaffiliated board members and influence their election to boards. One legal observer called this approach quasi-control because it uses board power rather than just ownership voice, as pension fund holders had used in the 1990s, although it falls short of actual corporate control. When activist fund representatives fill one or more board seats, their influence often leads to the replacement of significant corporate managers, such as the CEO or CFO, and the replacements often favor the strategic decisions preferred by the activists.
In wolf-pack activism, funds ready for aggressive campaigns team together with other activist investors. This tactic may include securing minority board representation (especially by way of negotiated settlement), which represents a much cheaper alternative to engaging in a proxy contest or pursuing a hostile takeover. In this manner, activist hedge funds can pursue a number of different companies compared to focusing their efforts entirely on one or two targets. As such, the amount of capital that they need to invest in specific target companies has gone down over time.
What regulatory and other changes occurred to allow for an atmosphere of wolf-pack activism? Changes in Securities and Exchange Commission regulations and the entrance of shareholder proxy advisory intermediaries facilitated the changes. The SEC enacted a proxy access rule in 2010, though it was later vacated by the US Court of Appeals for the District of Columbia Circuit in 2011. However, in recent years, many S&P 500 companies have adopted proxy access bylaws, which usually allow shareholders who hold 3 percent of the shares of a company for at least three years the ability to nominate directors without going through a proxy contest. Rather than risk a proxy contest, firms have allowed more access to the nomination process. In fact, 88 percent of the board seats won in 2016 were achieved through settlement agreements rather than proxy contests, compared to 70 percent in 2013 and 66 percent in 2014.
Proxy advisory intermediaries, such as Institutional Shareholder Services (ISS) and Glass Lewis, have enabled the power of other institutional investors, often in support of the activist shareholders. Because institutional investors are significant shareholders, often having shares over the SEC 3 percent rule, they hold power to nominate directors directly during the proxy voting process. And because institutional investors frequently follow large proxy advisor voting recommendations, activist investors team with these intermediaries to get their board members elected. Under SEC rule changes and proxy advisor power, firm leaders are more likely to settle with activist shareholders and support a campaign for minority board representation rather than risk a negative vote in a proxy contest.
Sources: Benoit, D., & Grant, K. (2015). Activists' secret ally: Big mutual funds – large investors quietly back campaigns to force changes at US companies. Wall Street Journal,www.wsj.com, August 10 www.wsj.com/articles/activist-investors-secret-ally-big-mutual-funds-1439173910; Coffee J. C., & Palia, D. (2016). The wolf at the door: The impact of hedge fund activism on corporate governance. Journal of Corporation Law 41(3): 545–607; Baigorri, M., & Kumar, N. (2017). Black swans, wolves at the door: The rise of activist investors. Bloomberg, www.bloomberg.com, July 12; Christie, A. L. (2019). The new hedge fund activism: Activist directors and the market for corporate quasi-control. Journal of Corporate Law Studies 19(1): 1–41; Wong, Y.T.F. (2020). Wolves at the door: A closer look at hedge fund activism. Management Science 66(6): 2347–2371.
For board members to affect strategic governance, the same standard applies. Corporations often replace one or more directors each year. Each replacement represents a chance to shape the board to meet the corporation's strategic needs. An unexpected death of one director can shape corporate acquisitions strategy, which indirectly shows the impact on strategy that even one director can have.36 Not surprisingly, nominating committees increasingly seek board members with specific functional expertise, such as in labor, environmental, compensation, or public policy. For example, when a firm is experiencing operational problems, appointing a chief operating officer (COO) or CEO with operational experience from another firm helps the appointing firm to improve its performance.37
FIGURE 1.2 Board diversity of S&P 1500 firms.
Nomination committees may also seek directors to match diversity characteristics of customers or to extend operations into global markets. Diversity may improve board effectiveness. Growing evidence suggests that board gender diversity is associated with a number of desirable organizational outcomes, such as avoidance of securities fraud,38 more vigilant monitoring of the top management teams,39 more ethical firm behavior,40 and higher accounting-based performance and stock market returns.41 As Figure 1.2 shows, boards have become more diverse over time in regard to appointing more females and ethnic minority members. But these positives are stymied if, for example, solely one woman is placed on a board as a token to create institutional legitimacy.42 Recognizing the positive effects of diverse membership on boards, institutional investors are using their power to push companies to appoint more women and minorities. For instance, BlackRock, a large mutual fund manager, suggested that diverse boards “make better decisions” and that it planned to focus on the issue in discussions with company leaders ahead of annual meetings.43 Yet we note that diverse demographic characteristics do not always mean that the new “diverse” members will have diverse opinions as current board members. For example, directors are inclined to select a demographically different new director who can be recategorized as an in-group member based on his or her similarities to them on other shared demographic characteristics, and such recategorization also increases demographically different directors' tenures and likelihood of becoming board committee members.44 We also note that board demographic diversity can be detrimental to unity among members, making firms become attractive targets for hostile stakeholders; interestingly, as a result, firms with a more demographically diverse board are more likely to be targeted by activist investors, presumably because boards are unable to form an effective coalition against activist investors.45
The nominating and governance committees—sometimes held as a single, combined committee—carry out important functions. The governance committee can conduct a management audit, assessing the capabilities and potential of the company's board and management team, and suggest training to sensitize the directors to environmental, regulatory, or diversity issues that affect strategy. Such an audit focuses board attention on human assets and helps plan changes in leadership. In fact, succession planning forms another crucial issue under the purview of the governance committee. When a CEO is dismissed or moves to another firm, a board of directors without a strong succession plan may scramble for a replacement, which may lead to serious strategic consequences. Many boards have authorized their nominating committees to seek out potential executive talent to avoid shocks upon surprise departures. Some boards hold an annual joint session of the compensation committee, the nominating and governance committees, and the executive committee to discuss succession planning and executive resource development. Another important issue lies in appointing qualified board committee chairs. When highly qualified chairs are passed over and less qualified members receive chair appointments, the selections can lead to a negative board climate,46 which also may affect strategic governance. To avoid pitfalls from inadequate chair appointments or succession shocks, directors should formalize succession processes that can improve their information collecting and processing abilities and give rise to a greater quantity and quality of qualified chairs and CEO candidates.47 The following example demonstrates the hazard in not having a succession plan in place.
In mid-2020, leaders of Cerberus Capital Management, a private equity firm holding more than 5 percent ownership of Commerzbank, the second largest German bank, sent a letter to the board chair that the bank “has not presented a coherent strategy and has failed to implement even its own progressively less-ambitious plans.” Cerberus heads wanted to name two new supervisory board members to encourage significant changes to Commerzbank's supervisory board, management board, and the strategic plan. One month later, over disagreements with Cerberus (the bank's second largest shareholder), Commerzbank CEO Martin Zielke announced unexpectedly that he would step down from his position. The abrupt announcement came as a surprise and reduced the value of the firm, while the departure left a governance void at the bank.48 Compared to German competitor Deutsche Bank's 1 percent loss, Coomerzbank shares fell 26 percent, when a new CEO was appointed in September 2020.49
