CONVERGENCE OR DIVERGENCE IN CORPORATE GOVERNANCE: EMPIRICAL EVIDENCE 47
5. THE BOARD SYSTEM
It also seems that this regime can be found, de facto, in the U.K. As Pettet (2000) states:
Davies (2001) argues that these formal differences are not functional because whatever the board structure may be, its value as effective monitoring mechanism can be criticised. Based on arguments like the 'path dependency theory', one can state that there are relative merits for both systems: a two-tier board structure serves the business culture in Germany while a one-tier board seems the only right solution for the British business community. Gerhard Cromme, the main architect of Germany's new corporate governance code and chairman of the supervisory board of ThyssenKrupp, indirectly refers to this:
These differences refer to the different role attached to the firm in society and the consequences of such differences for structuring corporate governance. People that believe in a stakeholder model are convinced that a two-tier model is the only guarantee for a balanced respect for the interests of the different types of stakeholders involved. In a recent publication, Turnbull (1998) stated that:
5.2 Board composition
5.2.1 Board size
There are legal as well as practical differences that influence the number of board members. To analyse the composition of the board, it is clear that the unitary board, with executive as well as non-executive directors, must be compared with the two boards in the dual board system. Within the dual board system considerable differences exist. The supervisory board of German companies is of a 'representative' nature. In larger firms members of this board represent either the
shareholders or the employees. Both parties have the right to equal board representation, except for the president of the board, who represents the shareholder and has a casting vote. Consequently those boards can have numerous members.
This is significantly higher than in the Netherlands where, up till now, no obligatory representation system exists and all members of the supervisory board are expected to be independent (with only the legal obligation of a minimum of three directors for companies who are under the full structure regime).
Figure 15 shows a wide variety in the number of board members across Europe.
Italy, France, Belgium and Spain have on average a larger board than the European average. Between 1999 and 2001, the European average declined from 13,5 to 12,5 board members.
5.2.2 Relative importance of outsiders and independent directors
5.2.2.1 Emphasis on independence of the board of directors
Another major topic concerns the independence of the board. In almost all corporate governance codes and recommendations great reliance is placed on a sufficient number of outsiders (non-executives) and especially independent directors. The key requirement is that directors should be truly independent of day- to-day operations of the company and of the managers. This is in respons to the
116 Heidrick & Struggles (2001), p. 9. In countries with a two-tier system, the numbers refer to the supervisory board.
overwhelming impact of managers in –a typical "Berle & Means" firm, where dispersed shareholders are not able to exercise sufficient countervailing power. In Continental European countries, characterised by weak shareholder control of managers, the emphasis is far more on independence in comparison to reference- shareholders or blockholders.
So, although the emphasis world-wide is on a truly independent board, important differences continue to exist as to how such independence is interpreted. In fact, independence is necessary to guarantee a sufficient countervailing power. As such independence is a remedy against the most important types of governance problems (conflicts of interests and abuse of power). Since the control and power structures differ substantially across nations (see section 2 of chapter 3), one should define independence differently. A different disease indeed needs a different type of medicine: e.g. if managerial entrenchment is a potential threat, independence in relation to managers is the remedy; on the contrary if the danger is more that reference shareholders will capture private benefits, independence in relation to these shareholders is of importance.
The growing emphasis on outside directors has led to a decreasing proportion of executive directors. Since the introduction of the Cadbury Code, many companies in the U.K. now have a majority of non-executive board members. This corporate governance feature has been adopted all over Europe.
In different countries, corporations, especially the largest ones, elect independent board members. In many cases this is due to the pressure of international institutional investors. In France the majority of the CAC-40 corporations have a majority of independent board members. Table 15 suggests that the election of independent board members is also starting in smaller countries like Belgium.
5.2.2.2 Critique on the overwhelming emphasis on independent directors
It is clear that independence of governance bodies like the board of directors and audit committees get world-wide attention. Our previous research clearly has proven that independent boards do make a considerable difference for the quality of board meetings, the degree of open and frank discussions and the "richness" of the agenda117. However, it may not be ignored that critique is growing on the
117 Van den Berghe and Wymeersch (1999).
overwhelming emphasis on independence in general and independent directors more specifically.
Romano (2002) found that "the benefit to shareholders from an independent board's performance in certain extraordinary situations is sufficiently limited to render more important the overwhelming evidence that independent boards do not produce overall improved performance". However, she indicates that optimal board structure may vary across firms, because the choice of board structure is endogenous to management. She concludes that firms possibly are sub-optimising board composition by nominating too many outside directors.
Bhagat and Black (1998) interpreted the limited effect of the independence of boards in a number of ways:
The neutral evidence on the value of the independent directors could be of a statistical nature (neutrality reflecting the limited power of the tests).
It is possible that only certain types of independent board members are valuable board members.
Like argued by Gilson and Kraakman (1991), and Bhagat and Black (1998), maybe independent directors are not independent enough.
Independent directors are only efficient if embedded in an appropriate committee structure.
It is possible that the efficiency of independent directors depends on the firm type or industry.
The optimal board must contain a mix of executives, non-executives and independent board members.
Bhagat and Black conclude that it is possible that "board independence may simply not be very important".
From business practice, the Enron case has triggered the debate on the role and effectiveness of independent directors. Peel and Hill (28 January 2002) state that
"the attack highlights accusations that nominally independent directors of Enron failed in their duty to scrutinize the company's management and accounts".
5.3 Organisation of the board
5.3.1 Frequency of board meetings
The type of board structure and the type of firm will influence the frequency of board meetings, and indirectly its role and functioning. Some international information is available on the number of board meetings. This kind of information indicates the extent to which the board of directors regularly supervises the management and follow the implementation of strategic decisions. In some reports it is mentioned that German supervisory boards do not regularly meet but instead decide important topics ad hoc during informal contacts (see Figure 16). German
companies hold on average less than five board meetings a year118. Boards in France, Belgium, the Netherlands, Sweden and the U.K. all meet between 6 and 8 times a year. Italian companies have monthly board meetings. The evolution in the European average suggests that boards meet more frequently compared to 1999.
5.3.2 Board committees
Within boards there are a number of committees set up to scrutinise several specific board tasks. This trend was first developed in Anglo-American countries but it is now rapidly spreading throughout all European countries. In general, the three most important committees are the audit, remuneration and nomination committee.
Data on larger listed companies indicates that the audit committee is already well established in all European countries. 66% of European companies have an audit committee. If at least one committee is created it is in 74% of the cases an audit committee.
The number of remuneration committees has substantially increased by 60%.
62% of all European companies in a national index have a remuneration committee.
Even in smaller companies a significant number established a remuneration committee.
The third committee, a nomination committee is not frequently found.
Nevertheless, 47% of all companies in a national index report the existence of such a committee.
118 However the data are not clear whether "Vorstand" meetings or "Aufsichtsrat" meetings are studied.
119 Heidrick & Struggles (2001), p. 10.
5.4 Directors' remuneration structure
Substantial difference of opinion exists as to the determination of the remuneration of board members. In the U.S. performance related pay for executives and non-executive directors is the prevailing recipe. This model has been exported to many other countries as far as executives are concerned. For non-executive directors many countries rely on non-performance related pay. In some countries, codes contradict the use of performance related pay, e.g. the Dutch Peters' code explicitly discourages performance related remuneration of non-executive directors.
5.5 Conclusion
Overlooking the previous analysis, one may conclude that, notwithstanding the quite diverse board practices with respect to structure, size, organisation and remuneration throughout Europe, the board practice tends to point to a converging trend with a substantial influence of Anglo-American standards.