How boards of directors can work against corporate misconduct

Boards should be seen as a crucial bulwark against scandal for companies

A view of  Enron  headquarters  in Houston, Texas,  US, on January 22nd, 2002.  File photograph: AP Photo/Pat Sullivan

A view of Enron headquarters in Houston, Texas, US, on January 22nd, 2002. File photograph: AP Photo/Pat Sullivan

 

Enron, WorldCom, Siemens, Volkswagen, BP and Wells Fargo. Every now and then a corporate scandal tops the global news headlines. CEOs and business magnates topple, shareholders wait nervously and the average person on the street expresses mild shock and fierce disapproval, ever cynical of glossy promises of corporate responsibility in the business world.

While companies have long been criticised for irresponsible behaviour, and justice doled out in the form of hefty fines, companies survive and companies continue to stray from the path of good. Why?

Perhaps, just like human beings, corporate entities are full both of light and goodness and also of shadow and imperfection. It is even possible to do good and bad at once – look at Walt Disney, criticised for labour and human rights violations in its supply chain while being recognised as the world’s best employer in 2018. Perhaps, also, because the mechanisms to keep them on the straight and narrow have not yet been perfected.

All above board

While corporate social responsibility – CSR – has been well researched, the seedier side of business – CSiR, or corporate social irresponsibility – has received scant attention despite the damage it can do to a company’s image and share price and to customer trust.

Recent studies on corporate governance have highlighted the pivotal role of boards of directors both in setting corporate agendas and strategies and in effectively keeping track of what management and ops are up to.

When a high-profile corporate scandal occurs, much of the irresponsible activity is known to occur because of executive mismanagement, lack of board oversight and poor governance practices.

Held liable for CSiR, a board can use their power to lead corrective actions. For instance, in the case of sexual harassment by CBS chief executive Leslie Moonves, the media group’s board committed publicly to a thorough and independent investigation, and subsequently discharged Moonves without any golden parachute.

Board size

Boards, then, are important, not only for what they do but how they do it. A board’s size has a role in how its members interact, their ability to process information, how effectively they participate in meetings, and the quality of their monitoring of managerial decision-making and actions.

In theory, because there are more people sitting on them, larger boards are more likely to represent the interests of multiple stakeholders, including shareholders, than smaller boards. As such, they should be more effective in reducing CSiR. The more people you have, the more skills sets you have to tackle complex issues.

But then again, having many people making decisions might lead to slowness, freeriding, politicking and conflicts between clans.

It stands to reason then that smaller boards should be agile, more committed and accountable. On the downside, smaller boards have a greater likelihood to be dominated by a short-term, profit-oriented focus and by powerful manager-directors inclined to take risky decisions that might lead to an increase in CSiR behaviour.

Independence is a key factor. It is generally accepted that independent directors are better monitors and better in improving firm performance. Even though they may not have regular information on a company’s challenges and opportunities, they represent stakeholders with their knowledge and expertise and are thus likely to steer away from, and discourage others in being tempted by, CSiR to retain their reputational capital.

Board often rely on committees to deal with issues ranging from quality to project management and innovation. These meet and carry out work, bringing recommendations back for approval of the full board. As stakeholders become aware of the risks linked to irresponsibility and to unethical behaviours, companies increasingly consider the creation of CSR committees to address socio-environmental issues. They tend to have a good record. They encourage extra vigilance on green issues and improve the firm’s social performance.

Gender and focus

Gender, of course, impacts on corporate performance. The good news for women is that, in much research, they come out on top. They have been found to be more sensitive towards ethical judgements and set higher ethical standards than their male counterparts – even when under pressure to give way. Women have also been found to give more emphasis to CSR practices.

Greater diversity on boards gives a broader variety of perspectives, generating better solutions during problem-solving and ultimately improving board effectiveness.

What’s more, women are less lazy. Female directors are more likely to attend board meetings than men. This is important. For when directors fail to attend meetings, it signals their unwillingness or inability to fulfil their role as monitors. Lower attendance at board meetings can also encourage managerial opportunism at the expense of stakeholder claims and interests.

In short, it’s not the frequency with which board meetings are held that is important, but the frequency at which directors attend those meetings that really counts.

Having a good bundle

Research I have undertaken highlights that the number of irresponsible incidents and the cost related to them have risen drastically across all industries between 2002 and 2015 in a sample of publicly listed US companies, notably following the global financial crisis. Trawling through the practices of the 1,591 businesses reveals a pattern: CSiR is reduced when governance is bundled in a certain way.

This governance bundle includes large and more independent boards, a board CSR committee, more women on boards, and higher director activity.

Additionally, the effectiveness of the bundle improves under two conditions – institutional ownership and higher director pay.

Where investors are insurance companies, banks and endowment funds, they have the resources, long-term vision and concern for their own reputation to ensure that businesses in which they invest stick to the straight and narrow.

Higher pay for directors may jar for those who tend to link a fat pay cheque to shady dealings, but the fact is that pay acts as an incentive for boards to look after the long-term interests of shareholders and the firm and keep a sharper look out on what type of decisions their managers are making.

When properly structured, boards can substantially reduce stakeholder mismanagement. And it might just keep your company from toppling Volkswagen at the top of the CSiR charts.

From the paper When Boards Matter: The Case of Corporate Social Irresponsibility, British Journal of Management, Vol. 00, 1-22 (2019), DOI: 10.1111/1467-8551.12376 by Tanusree Jain, Trinity Business School, Trinity College Dublin. Member CoBS.

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