Independent Directors’ Dissent on Boards

The following post comes to us from Tarun Khanna and Juan Ma, both of the Strategy Unit at Harvard Business School.

Independent directors are an integral part of corporate governance. Despite the copious scholarly debates surrounding board independence, little progress has been made in studying the inner workings of public boards. Taking China as an empirical site, in our paper, Independent Directors’ Dissent on Boards: Evidence from Listed Companies in China, which was recently made publicly available on SSRN, we offer one of the first statistical investigations of the circumstances under which so-called “independent” directors voice their independent views. Unlike most of the previous models that view boards as a monolithic entity that “shares a common agenda on all matters” (Hermalin and Weisbach, 2003), our data allow us to see boards as consisting of individuals with different utility functions and to examine board behaviors at the individual director level. We view this as the first step in a long research journey.

Although we cannot observe all expressions of board independence, we show that independent directors dissent more when social connections that might hold back a dissent is less constraining on one hand (Berle and Means, 1932), and when firms have poor performance that might impose threats to independent directors’ personal reputations on the other hand (Fama 1980; Fama and Jensen, 1983). Our work suggests that there is value to reconceiving boards, not as monolithic checks on managerial actions (e.g. Uzun, Szewczyk, and Varma; 2004; Klein, 2002; Bhagat and Black, 1999; 2002; Cotter, Shivdasani, and Zenner, 1997; Beasley, 1996), as suggested by the stylized principal-agent models, but as social institutions with emergent norms, and sanctions and rewards to (non-)compliance on occasion. Our findings suggest that the labor market not only rewards independent directors for their superior decision making expertise (Fama and Jensen, 1983), but might also punishes those who have openly challenged the companies’ management teams (Adams, Hermalin and Weisbach, 2010).

This paper has many limitations, which highlights further trajectories for empirical research. First, the idiosyncratic institutional context has nontrivial implications on the internal dynamics of corporate boards. In SOEs, independent directors have to play a “game” within a “game”. The smaller game is within a particular board, and the larger game takes into account that board chairpersons are regularly rotated to another board by the Party, or that independent directors have to leave the boards after six years. In this paper we confine our analyses to the smaller game in which board members are required to reveal dissent within a particular board. In future work, we will examine the larger board games that take into account that board members are regularly rotated between boards.

Second, idiosyncrasies of the Chinese institutional context make extrapolation to other contexts challenging. We conjecture that China provides a lower bound for independent directors’ dissent. Due to the legal necessity that dissent needs to be revealed, Chinese boards are expected to devote more efforts to resolve conflicts with independent directors. In addition, the Chinese institution is at its early stage. Both boards and independent directors have gradually learned how to play the board “games”. A fascinating research avenue is to examine independent directors’ voting patterns in a wide range of institutional settings, in particular, in advanced institutions where disclosure of dissent is not mandatory.

Third, we confine our analyses to the independent director–board chairperson dyad, in keeping with the Chinese leadership tradition and the rest of the recent literature on social relationships among board members (Hwang and Kim, 2009; Coles, Daniel and Naveen, 2010). To gain further insights on the strategic interactions within boards, future research might want to consider a higher-level social connection structure, for instance, a structure that takes into account social influence and multisided social connections within public boards. Of course, this is harder to operationalize. Last but not least, we expect that in the near future empirical studies on internal workings of boards will move beyond surveying public companies, of particular importance are startups and nonprofit organizations.

Both the Chinese institution and the empirical work on boards’ inner workings are works-in-progress. Nonetheless, our findings have several implications to policy makers and independent directors in the transitioning stage. For Chinese policy makers, we confirm the idea that board actions are influenced by the board selection process to a great extent (Berle and Means, 1932). For Chinese independent directors, our work suggests an inescapable dilemma whereby the Confucian doctrine of Golden Mean is the only survival guide, that is, independent directors must ensure that their relationships with listed companies are conducted on an open and mutually advantageous basis. On one hand, independent directors need to build a good public reputation for being an active monitor, and on the other hand, they need to establish a good “private” reputation for being friendly with the controlling shareholders and top management.

The full paper is available for download here.

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