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Accountancy

The Cost of Intense Board Monitoring

“Once upon a time, serving as a corporate board director was a prestigious thing. Today, thanks to the intense burdens of monitoring and governance we’ve piled onto boards generally and independent directors specifically, board service is more like a pain in the backside. And now some clever academics have tried to quantify precisely how much that pain costs corporate operations” (Compliance Week, November 15, 2010).

The boards of directors of public companies have two primary responsibilities: The first is to advise management on how to best create value; the second is to oversee management and align shareholders and management interests. In a study published in the Journal of Financial Economics, Professors Olubunmi Faleye, Rani Hoitash, and Udi Hoitash examine whether too much emphasis on one responsibility detracts from time devoted to the other. The logical argument is that if you ask independent outside directors to serve on multiple board oversight committees, their effectiveness of watching over management might improve. Yet, these directors may not dedicate enough time to advising management.

Indeed, this study finds that devoting greater board resources to oversight duties on the audit, compensation and the nomination committees leads to improved oversight. If the majority of independent outside directors serve on two or more of the primary oversight committees, there is less excess CEO compensation, higher reported earnings quality and a more likely replacement of under-performing CEOs. However, while these improvements are aligned with the interests of shareholders, they come at a significant cost of weaker strategic advising, greater managerial myopia and lower firm value. The study finds that corporate acquisition performance, research and development investments, the quality of patents, and overall firm value, all suffer as a result of too much board emphasis over management oversight.

The findings of improved monitoring provide an empirical basis for recommendations of increased independent director involvement in oversight duties. However, the deterioration in advising quality associated with intense monitoring suggests that an exclusive focus on board monitoring can be detrimental. Thus, there is the need to balance directors’ monitoring and advising duties in the design of value-maximizing governance structures. More importantly, results challenge the one-size-fits-all approach often favored by regulators, shareholder activists, and the popular press. Therefore, boards should be cognizant that exclusive focus on board monitoring and management oversight can have unintended consequences, which could lead to a deterioration rather than an increase in shareholders’ value.

Deterioration in advising quality suggests that an exclusive focus on board monitoring can be detrimental.