Corporate Governance: Review the Theoretical and Empirical Literature on Board Leadership Structure and Impact of Leadership Structures on Firm Performance
1.0 Introduction
Davies (2012) accounts for the corporate governance being a product of government development concept that has existed since early days of the social organisation. Corporate governance has evolved into constitutions in nations. Such national consideration of corporate governance is depicted in the case of Parmalat, which is considered a case of Italy (Melis, 2005). The structure and principles of corporate governance vary depending on the organizations they are applied. Corporate governance is critical in ensuring that organisations make and implement decisions that prevent them from the collapse of any form of mismanagement (Lipton, 2003). Lipton accounts for the failure of HIH Group due to compromised corporate governance roles. According to Council (2010), corporate governance refers to a framework comprising systems, relationships, rules and processes that are used to control and exercise authority in a corporation. The systems provide ways in which a company and its executives are held accountable. Daily, Dalton, and Cannella (2003) define corporate governance as a system of deploying an organisation’s resources, and conflicts of the stakeholders are solved. Therefore, corporate governance refers to a system of regulating conduct, ensuring effective resource allocation and settling disputes of stakeholders in an organisation (Council, 2010; Davies, 2012; Lipton, 2003).
The above definition implies that corporate governance concerns with assurance provision that the executive will work for the benefit of the stakeholders (Daily, Dalton & Cannella, 2003). The achievement of such alignment of the stakeholders’ objectives with those of the managers requires setting up means for oversight role. Consequently, there is a board that acts as an internal oversight mechanism while the corporate control market acts as the external mechanism (Council, 2010). The boards in a corporate have diverse duties and responsibilities that ensure effective operations and performance in an organisation. According to Melis (2005), one of the roles of boards is to ensure conformance with the legal and the company’s corporate governance requirement. The board is also expected to play a role in the setting of company policies and strategies by the management (Lipton, 2003). Melis (2005) further explains that the board is required to ensure that the resources, including information, are sufficient to ensure effective operations of the company. Additionally, the board is required to ensure control in the activities of the management and review of the company’s activities (Davies, 2012; Melis, 2005).
This paper seeks to explore the aspect of boards in corporate governance. This exploration of corporate governance board is done considering two aspects. The first aspect concerns with conducting a review of the theoretical perspectives regarding the board leadership structure concept. The paper considers some of the most prevalent theories on the leadership of the board. The paper also performs a review of the role of the board leadership structure on the performance of a company. Moreover, the paper considers variances in the structure of leadership boards internationally.
2.0 Theoretical Perspectives on Board Leadership Structure
Organisations have been faced with the need to control the operations of its executives to prevent them from actions that may be harmful to their operations. According to Gabrielsson, Huse and Minichilli (2007), corporate governance has been faced by such as an unexplainable rise of executive compensations, corporate scandals and bankruptcies in organizations. Likewise, Lipton (2003) highlights areas where corporate leadership failed in HIH Group, an insurance company in Australia, that resulted in its collapse. Also, Melis (2005) gives examples of violation of legal requirements as stipulated in the Preda Code by Parmalat Company in Italy. The occurrence of such events has made regulation of corporate leadership a critical area. Daily, Dalton, and Cannella, (2003) explains that theoretical perspectives are critical in explaining the practices of corporate governance. There exist various theories used in explaining corporate leadership. Such include the agency and the team production theory (Gabrielsson, Huse & Minichilli, 2007). Coleman (2004) explores Kelly’s and Heider’s theories that are an example of implicit leadership. Also, there are resource dependence, institutional, legalistic perspective and stewardship theories (Daily, Dalton & Cannella, 2003). According to Van Ness, Miesing and Kang (2009), the most frequently used theories are agency, stewardship, and resource dependence theories. The following section considers the agency and the stewardship theories. The section also compares and contrasts the two theories.
2.1 Agency Theory
The agency theory stipulates that separation of corporate ownership from management results in deviation of the manager’s behaviour, actions, and decisions from those that would maximize the value of the shareholder (Van Ness, Miesing & Kang, 2009). The theory assumes an imminent divergence between the principals and the agents. The principal refers to the providers of the capital while agents are the fiduciaries. The basic discipline for the theory is economics (Pande, 2011). It is the most dominant theoretical perspective used in corporate leadership governance (Daily, Dalton & Cannella, 2003). The dominance of the theories application is attributed to two factors. The first factor concerns with the simplicity of the theory. In this case, large corporations are reduced to two participants whose interests are assumed as being clearly known. The second aspect involves the theories’ account for the self-interest of the humans. Daily and colleagues explain that human beings have self-interests and are unwilling to sacrifice them for those of others.
Ayuso and Argandoña (2009) explain that agency theorists perceive the boards function as of monitoring the managers actions on shareholders behalf. Regarding this role, the effectiveness of the board’s role of monitoring is determined by its independence from the CEO and the organisation’s influence. Consequently, the theory promotes the separation of roles of the CEO and board chairman. The theory can be summed as one professing that management is effective if it generates value that accrues to the firm’s shareholders (Crowther, 2007).
2.2 Stewardship Theory
Daily, Dalton, and Cannella (2003) state that stewardship theory gained the attention of researchers. The theory has been explored both as a contrast and a complement to the agency theory. The theory stems from sociology and psychology principles (Pande, 2011; Van Ness, Miesing & Kang, 2009). The theory perceives managers as to work for the shareholders’ best interest (Yusoff & Alhaji, 2012). The theory focuses on manager’s behaviour in which managers are considered to be collectivists and pro-organisational (Al Mamun, Yasser & Rahman, 2013). Moreover, manager’s behaviour is viewed as not to be deviant from shareholder’s interests and do not facilitate self-interests. Stewards are considered to balance the tension between all the beneficiaries and other stakeholders.
Nicholson and Kiel (2007) explains that stewardship theory advocates two principles. The first principle claims that managers are trustworthy. Managers are viewed as to work for the benefit of the shareholders. The other principle of the theory concerns with its ability to minimise agency costs. Stewardship theory professes that there is a strong relationship between a firm’s success and the managers (Yusoff & Alhaji, 2012). Stewards are motivated and satisfied only when an organization succeeds (Pande, 2011). Such an association advocates for the CEO duality (Yusoff & Alhaji, 2012). The theory professes that better performance by an organization is achieved if the same person holds the CEO and chairman positions.
2.3 Contrasting and comparing agency and stewardship theory
As earlier mentioned, stewardship theory promotes for CEO duality (Donaldson & Davis, 1991; Yusoff & Alhaji, 2012). The theory advocates that the same person should hold the CEO and the board chairman position. In this case, the theory stipulates an alignment of the interests of the managers and those of the shareholders. On the contrary, the agency theory disputes this fact. It advocates for the separation of the two positions of CEO and the chairman (Al Mamun, Yasser & Rahman, 2013; Donaldson & Davis,1991). Agency theory states that managers are likely to facilitate self-interests, which are different from those of the shareholders. This fact also leads to the issue of agency cost. In stewardship theory, the agency cost is reduced since motivation of the managers is not required. On the other hand, Yusoff and Alhaji (2012) explains that agency theory requires motivation of the managers to work in the shareholders’ best interests. Such need to motivate the managers incurs the agency cost and also monitoring costs (Al Mamun, Yasser & Rahman, 2013).
Donaldson and Davis (1991) also differentiate the two theories regarding performance. Donaldson and colleague explain that stewardship theory results in better performance in an organization. On the other hand, agency theory has been associated with poor performance. These inferences on performance were based on return on equity. Nicholson and Kiel (2007, p. 597) explain that stewardship theory allows managers to make managerial decisions that are more informed compared to agency theory. Leadership structure based on stewardship theory allows superior access to information that results in better and informed decisions.
Nonetheless, the two theories do not account for the relationship between the composition of the board, the structure of leadership and the performance of an organisation (Nicholson & Kiel, 2007). The two theories do not show how the role of CEO and chairman in both cases results in improved performance.
3.0 Empirical Literature Review-Effect of board leadership structure
There are empirical studies that largely associated the CEO duality with the poor performances of the organisations. Syriopoulos and Tsatsaronis (2012) noted that the CEO duality had a negative impact on the financial performance of the firms involved in the shipping activities. The research found that results of the negative performance were the same irrespective of whether the Return on Assets (ROA) or the Return on Equity (ROE) was used as a measure of the performance. Iyengar and Zampelli (2009) concluded that CEO duality has no correlation with the firm’s goal to maximise the profit or any related comparative advantage. Whether the performance of the company is measured in terms of the earning per share or the returns the performance of the firm is suboptimal. Melis (2005) investigated on the failure of the Parmalat, which is a popularly known case of a firm in Italy. The study noted that it was significant that very different persons hold the position of a chairperson and the CEO. Besides, it is noteworthy to provide a clear separation of the responsibilities of the Chairperson and the CEO. The empirical evidence revealed by Melis (2005) revealed that at the time that the failure of Parmalat occurred, Tanzi held the position of the CEO and the chairperson. The fact that he was still a major shareholder of the firm led to the increased concentration of the powers to a single person.
Different researchers have provided empirical evidence favouring the stewardship theory. For instance, Yang and Zhao (2014) noted that despite the increased pressure from the activists for the abolition of the CEO duality, duality firm’s performance outperformed the non-duality firms. Yang and Zhao (2014) empirical study disrupted the relationship between the choice and the outcome of the endogenous variable using the Free Trade Area agreement signed by the Brian Mulroney and the Ronald Reagan, the Canada Prime Minster, and the USA president respectively as an exogenous shock.
The empirical observations made for the ten years that marked the implementation of the FTA agreements resulted in a conclusion that the duality firms outperformed the non-duality firms by 4%. Moreover, Dekker (2013) noted that CEO duality had a positive impact on the improvements of the performance of a firm in times of crisis. Dekker made the observations during the crisis of 2008-2009. Previous research had brought contradictions on the significance of the CEO duality to the performance of the business organisations. Nevertheless, Dekker (2013) noted that the duality had no significant impact on the performance of the organisations in a stable environment. Besides, Camaral-Baptista (2011) found that CEO duality contributes to the positive performance of the firm when the performance was measured on the subject of the Returns on Equity (ROE). Vo and Phan (2013) empirical study on the impact of the CEO duality on the firm’s performance had found a positive relationship between the performance of the firm with the CEO duality.
Other empirical studies have failed to identify any significant impact of the CEO duality on the performance. Dekker (2013) noted that there is no leadership structure that would be described to be optimal. The effect of the performance of the CEO duality on a company is dependent on the industry in which the firm belongs. In some companies, the CEO duality would be very profitable while it causes losses in the other companies. The CEO duality relationship with the performance of the company should be viewed to be dynamic rather than being monotonic.
Hassanein and Wahsh (2012) also found mixed finding on the effect of CEO duality on the performance of a firm. Hassanein and colleague suggested an alternative action in which the companies would utilise other methods that would enhance the performance of the company. For instance, the audit committee of the bank would enhance its economic value through the adequate managements of the assets and liabilities. Costa (2015) found it difficult to make a conclusion on whether CEO duality has an impact on the performance of a firm. Nevertheless, the CEO duality was partially found to have a positive impact on the performance of a firm.
4.0 International Variance in the Board Leadership Structure
The board leadership structure differs among different countries. The increased competition in the USA has made companies adopt the CEO duality structure. Dalton and Kesner (1987) noted that there are no major differences between the board leadership structures in the United States of America and the United Kingdom. On the other hand, when either of the UK or the USA was compared with the Japan, a significant difference between on the CEO duality was discovered. In Japan, companies have maintained a culture that one person cannot serve as a CEO and at the same time as the chairperson of the board. The practice is very common in the United States as well as the United Kingdom
The legal system determines the board leadership structure adopted in a given country. Elsayed (2010) noted that many researchers have concentrated on providing research supporting the agency or the stewardship theory. The researchers failed to consider the major determinants of the board leadership structures. The common law of both the United States and the United Kingdom are both build up from the Anglo-American law. Nonetheless, the law in the Egypt is high influenced by the French Law system. The law in the Egypt does not prohibit the CEO duality. The law clearly states that the board of the directors should be constituted in a manner that represents the interests of the shareholders and in agreement with the capital contributions (Elsayed, 2010).
5.0 Conclusion
It is evident that there existed a different board leadership structure and supported by the different theoretical perspectives. The stewardship theory and the agency theory support different board leadership structures. Moreover, the empirical studies provide different conclusions regarding the performance of the company and the CEO duality. Some of the studies have found that the CEO duality is vital in enhancing the performance of a firm. Other studies have found otherwise. Therefore, if theoretical and the empirical perspectives are considered, the decision makers would end up being confused. Conversely, some important facts are noticeable and can help in the adoption of a suitable board leadership structure.
The firms should make efforts to choose the board leadership structure that fits best for the company. Decker (2013) noted that there is no method that would be described to be optimal for enhancing the performance of a business organisation. The CEO duality would favour the performance of some of the companies while it would be detrimental to the performance of some companies. The application of theories of stewardship and agency would only apply under specific conditions. Majorly the managers should make an effort to understand the condition and the needs of the organisation. Sometimes, relying on a single understanding of the board leadership structure would result in wrong conclusions regarding the adoption a board leadership structure.
The application of the stewardship theory in the board leadership structure is also important, especially where there is a need for the radical change. Currently, the competition in the corporate world has intensified. Thus, organisations need to control the costs of management as well as the application of a faster decision-making process. In the stewardship, there are no agency conflicts. The avoidance of the agency conflict makes the managers serve a company in an honest manner. In the stewardship, a mutual trust is created between the shareholders and the management thus enhancing the performance of the organisation. Furthermore, the manager has the capability to acquire accurate information that facilitates faster and prompt decisions.
Besides, firms should consider other methods that can facilitate the performance of the firm. Board leadership structure is not a sole drive of the performance of a company. Other methods such as empowerment of the audit committee would maximise the economic developments of the company. The committee is responsible for ensuring the value of the management. The firms should not rely heavily on the board leadership as the only method of realising high performance. Moreover, there is no a method that would be described to be perfect. The management and the environment in which a firm operates in highly determines the option that is to be adapted by the company.
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