Linking board structure, composition and organisational culture

Research highlights ways in which boards can improve their practices and processes beyond compliance with regulatory instruments

In GLC articles published in June this year, AICD Fellow Graham Bradley AM and GLC Consulting Editor Tony Featherstone discussed a number of key implications from the APRA Report into CBA’s governance of non-financial risks. In this article, we expand on these contributions by exploring some of the critical links between board structure, board composition and organisational culture arising from the APRA Report. The intent is to outline results from recent research rather than prescribe a magic bullet.

As Graham Bradley identified, one immediate standout from the APRA Report is that shortcomings in board oversight and non-financial risk management practices at CBA occurred despite long-term financial success and ‘industry best practice’ customer satisfaction ratings. So, how did that happen? Did the CBA structure and board composition play a role in these governance failings? What about the boards’ role in shaping the CBA’s organisational culture? Let’s start by clarifying what we mean by board structure and composition.

The ASX Corporate Governance Principles and Recommendations provide for principle-based governance structures, policies, processes and practices. The recommendations have been developed following lengthy public consultations and take into account local governance norms. Recommendations for best practice governance structures can be found in Principle 2, which, for example, provides for a single rather than dual board structure. Principles 1 and 2 highlight the need for independent directors, diversity, and a mix of skills in the composition of the board. The ‘if not, why not’ approach to regulatory oversight aims to encourage widespread adoption of the recommendations.

Based on publicly available reporting, the CBA – along with the vast majority of ASX-listed companies – have complied with the ASX Principles and Recommendations on board structure and composition. Yet code compliance is not enough to ensure good governance. As found in the HIH Royal Commission and similar statutory reviews following past corporate collapses, it can be catastrophically misleading.

Organisations need to look beyond regulatory instruments when implementing processes and practices to improve the quality of board discussions and decision-making. A recent Harvard Business Review paper by two U.S. based board practitioners, Parsons and Feigan (2014 p. 100) identify board practice innovations that go beyond ‘best practice’ compliance in four main categories: ‘strategy and talent oversight’, ‘board composition’, ‘the quality of board discussions’, and ‘the board’s relationship with the CEO’. Whilst these evolving practices work best in tandem, an illustration provided by the authors of an evolving practice is the increasing use of specialised business review sessions and site visits in preparation for upcoming board decisions. This practice affects board composition to the extent that today’s directors need to be able to look beyond compliance to complex and critical areas of the business.

Recent literature has examined various features of board structure and composition in an attempt to isolate, define and examine the variables that impact on board effectiveness and organisational performance (both financial and non-financial). Research examining corporate governance practices in different jurisdictions is particularly pertinent at present, as governance scholars, commentators and practitioners seek solutions to the problems that APRA identified in its Report.

For example, recent literature on board structure has empirically examined the relative performance of single and dual-board structures. There have been mixed results. A paper by Block and Gerstner (2016) comparing these two structures in the U.S. and Germany respectively concluded that both have material strengths and weakness with evidence of system convergence in both jurisdictions. The researchers note that the American board may be better described as a ‘1.5 tier’ (rather than a one tier) board. They further note that “[s]upervisory duties, though not legally separate like in the German model, have been heightened and delegated to the point of constituting something unique, and substantively different than a unified one tier board.” (Block and Gerstner, 2016 p.51).

To further illustrate the mixed results of comparative research, studies on Chinese private companies have concluded that an Anglo Saxon model with a single board has a stronger link to company performance and should be implemented more widely as Chinese companies continue to grow (for example Chen et al, 2006). In contrast, other papers (for example Young, Peng, Ahlstrom, Bruton and Jiang, 2009; Chen, 2008) have argued that there should be continued acknowledgement of Chinese business practices as well as the importance of family shareholdings and other forms of concentrated ownership, including two tiered board structures inspired by German corporate governance practice.

Other aspects of board structure have also been examined in the corporate governance literature. In particular, there is a large literature examining characteristics such as board size (for example, Pathan, Haq and Gray, 2013 in a banking context), industry context (for example, Chancharat, Krishnamurti and Tian, 2012 in an IPO context) and governance systems. An example of the later is Yoshikawa, Zhu and Wang (2014) who suggest that corporate governance systems are best categorised as components consisting of configurable practices that can be combined in different ways to reflect different national institutions, ownership structures and board composition. Consistent with comparative governance studies in the management literature (Aguilera and Jackson, 2010), recent calls for consideration of Nordic corporate governance structures in Australia may benefit from such a perspective given the ownership and institutional differences between jurisdictions and historical practices in the respective countries.

Recent literature on board composition has tended to focus on specific aspects such as director independence and board diversity. Many of the studies involve quantitative analysis and attribute modeling. For example, Sur, Lvina and Magnan (2013) analysed the profiles of directors from a sample of approximately 1,500 U.S. firms with three broad types of owners in various proportions: institutional, corporate and individual/family. They found that the composition of a board generally matches the proportion of the mix in the broad owner types. Contrary to theoretical expectations, they found that the proportion of independent directors was not affected by aggregated ownership, reasoning that corporate code compliance has resulted in an increase in the proportion of independent directors regardless of ownership type.

Research on board diversity has tended to focus on aspects of gender. The results of this research is again mixed (Post and Byron, 2015) with some studies showing a positive link between increased female representation on the board and performance (for example, Francoeur, Labelle and Sinclair-Desgagne, 2008) and others being inconclusive (for example, Adams, Gupta and Leeth, 2009). Recent research has looked at the reasons for increased gender representation on the boards of publicly listed companies (as found in surveys of corporate boards, such as the AICD Quarterly Report on gender diversity), including studies of gender quotas (Bianco, Ciavarella and Signoetti, 2015) and female representation on board nomination committees (Hutchinson, Mack and Plastow, 2014). Research continues to examine the effects of increasing gender diversity on board processes and interpersonal dynamics, as well as the link to company performance (for example, Huse and Solberg, 2006).

A review of the literature on board composition and the characteristics of individual directors (Johnson, Schnatterly and Hill, 2013) has found that when research moves beyond analysis of publicly available data, a greater understanding of characteristics such as director experience, skills and competencies reveals a more complex relationship with board performance. An example of this type of research is by Piekkari, Oxelheim and Randoy (2015) who examined the interaction between board members, whose first language is not English, on nine multinational companies located in four Nordic countries. They found that the contribution of directors with limited language proficiency may impact the effectiveness of co-determination (i.e. the election of employee representatives on boards) in the Nordic corporate governance model. Chen, Dyball and Wright (2009) had earlier found links between diversity in board composition and diversification strategies in a sample of Australian listed companies.

It is worth noting that earlier research tended to exclude the human interaction aspects of board composition and decision-making. Studies on the oversight and shaping of corporate decision-making tended to focus on the outcomes of basic board functions such as oversight of executive policy-making, as well as strategy formation and accountability (to use the framework developed by Tricker in 1984). More recent research, however, has highlighted the complex interaction between board processes and composition. For example, Machold and Farquhar (2013) observed boardroom activities and examined the evolution of board tasks. They highlighted how the contingencies of individual firms (for example, lifecycle and business environment) can affect the extent to which individual directors (and boards as a collective) are involved in board tasks. This has a flow-on affect in relation to the make-up of the board.

In relation to corporate culture, a recent study (Tan, Chapple and Walsh, 2017 p. 617) looked at 42 ASX 200 companies identified as having a ‘fraud culture’ between 2000 and 2007. The researchers modelled the relationship between corporate governance measures (such as board composition and company ownership structure) and company performance. They found that “…‘strengthening’ of the corporate governance mechanisms employed in this study are not expected to improve firm performance – with or without the presence of a culture of fraud.”

Current academic research in relation to organisational culture has several key limitations (Evans (2013). The results of studies on culture are mixed, and often contradictory, partly because they examine different aspects of a very broad concept. In addition, identifying appropriate variables to measure culture is difficult. At the same time, practitioner models of organisational culture tend to have limited theoretical support and often focus on business operations rather than the board. As a consequence, there is limited research on the linkages between board composition and organisational culture.

As highlighted in the emerging themes paper published by the Governance Leadership Centre in 2016, there is a need for corporate governance studies that look beyond ideal characteristics or outcomes and focus on specific research questions and case studies that can help boards improve their practices and processes. In relation to board structure and composition, for example, we suggest further research into the role of ownership structures as well as director capabilities and experience in the operation of boards and interactions with executives. With the renewed interest in corporate culture, there are opportunities for further research. In particular, research could help illuminate the role of board tasks, processes and activities in shaping corporate culture, as well as the impact of board structure and composition on culture.

Professor Guy Ford is the Director of the MBA Program at the University of Sydney Business School. Dr James Rooney is an Associate Professor in Accounting and Governance at the University of New South Wales (Canberra) Business School. Louise Pocock is the Deputy Executive Director of the Governance Leadership Centre.

1Defined using prior academic literature as having “entrenched relaxed attitudes to fraudulent behaviour prior to reporting scandals” (Tan et al, 2017 p.602) and defined using data from the KPMG Fraud Survey published between 2002 and 2008.

References

Adams, S., Gupta, M.A. and Leeth, J.D. (2009). Are female executives over-represented in precarious leadership positions?, British Journal of Management, 20, 1–12.

Aguilera, R. V. and Jackson, G. (2010). Comparative and international corporate governance. The Academy of Management Annals, 4(1), 485-556.

Ben‐Amar, W., Francoeur, C., Hafsi, T. and Labelle, R. (2013). What makes better boards? A closer look at diversity and ownership. British Journal of Management, 24(1), 85-101.

Bianco, M., Ciavarella, A. and Signoretti, R. (2015). Women on Corporate Boards in Italy: The Role of Family Connections. Corporate Governance: An International Review, 23(2), 129-144.

Block, D. and Gerstner, A-M. (2016). One-Tier vs. Two-Tier Board Structure: A Comparison Between the United States and Germany. Comparative Corporate Governance and Financial Regulation. Paper 1. h9p://scholarship.law.upenn.edu/8sch_2016/1

Bonanno, J. B. (1976). Employee Codetermination: Origins in Germany, Present Practice in Europe, and Applicability to the United States. Harvard Journal on Legislation, 14, 947.

Chancharat, N., Krishnamurti, C. NS Tian, G. (2012). Board structure and survival of new economy IPO firms. Corporate Governance: An International Review, 20(2), 144-163.

Chen, G., Firth, M., Gao, D. N. and Rui, O. M. (2006). Ownership structure, corporate governance, and fraud: Evidence from China. Journal of Corporate Finance, 12(3), 424-448.

Chen, R., Dyball, M. C. and Wright, S. (2009). The link between board composition and corporate diversification in Australian corporations. Corporate Governance: An International Review, 17(2), 208-223.

Evans, G. L. (2013). Culture research and corporate boards. American International Journal of Contemporary Research, 3(5), 1-10.

Francoeur, C., R. Labelle and B. Sinclair-Desgagné (2008). Gender diversity in corporate governance and top management, Journal of Business Ethics, 81, 83–95.

Huse, M. and Grethe Solberg, A. (2006). Gender-related boardroom dynamics: How Scandinavian women make and can make contributions on corporate boards. Women in management review, 21(2), 113-130.

Hutchinson, M., Mack, J. and Plastow, K. (2015). Who selects the ‘right’ directors? An examination of the association between board selection, gender diversity and outcomes. Accounting & Finance, 55(4), 1071-1103.

Johnson, S. G., Schnatterly, K. and Hill, A. D. (2013). Board composition beyond independence: Social capital, human capital, and demographics. Journal of management, 39(1), 232-262.

Machold, S. and Farquhar, S. (2013). Board task evolution: A longitudinal field study in the UK. Corporate Governance: An International Review, 21(2), 147-164.

Pathan, S. and Faff, R. (2013). Does board structure in banks really affect their performance? Journal of Banking & Finance, 37(5), 1573-1589.

Piekkari, R., Oxelheim, L. and Randøy, T. (2015). The silent board: How language diversity may influence the work processes of corporate boards. Corporate governance: An international review, 23(1), 25-41.

Post, C. and Byron, K. (2015). Women on boards and firm financial performance: A meta-analysis. Academy of Management Journal, 58(5), 1546-1571.

Pugliese, A., Nicholson, G. and Bezemer, P. J. (2015). An observational analysis of the impact of board dynamics and directors' participation on perceived board effectiveness. British Journal of Management, 26(1), 1-25.

Sur, S., Lvina, E. and Magnan, M. (2013). Why do boards differ? Because owners do: Assessing ownership impact on board composition. Corporate Governance: An International Review, 21(4), 373-389.

Tan, D. T., Chapple, L. and Walsh, K. D. (2017). Corporate fraud culture: Re‐examining the corporate governance and performance relation. Accounting & Finance, 57(2), 597-620.

Tricker, R.I. (2009). Corporate Governance: Principles, Policies and Practices, Oxford University Press: Oxford

Yoshikawa, T., Zhu, H. and Wang, P. (2014). National Governance System, Corporate Ownership, and Roles of Outside Directors: A Corporate Governance Bundle Perspective. Corporate Governance: An International Review, 22(3), 252-265.

Young, M. N., Peng, M. W., Ahlstrom, D., Bruton, G. D. and Jiang, Y. (2008). Corporate governance in emerging economies: A review of the principal–principal perspective. Journal of management studies, 45(1), 196-220.