Does Good Corporate Governance Pay Off


Corporate governance got increased scrutiny after the wave of scandals following Enron’s collapse, which proved that executive oversight is more than a vacuous administrative function performed by a company’s board of directors. Academic studies have sought to confirm this by tying specific corporate governance principles to financial performance. But while researchers have been able to link certain best practices to the bottom line, such as gender diversity among directors, they’ve struggled to tease out a connection to others, including the impact of a combined chairman/CEO.

Should the CEO also be the chairman?
Charlotte, North Carolina-based Bank of America Corp. served as the latest poster child in the debate over whether a bank should allow one person to be both chairman and CEO, putting the matter up for a shareholder vote in September of this year, and winning approval for the combined roles from 63 percent of the shareholders. Shareholders of the $2.2 trillion asset bank had voted in 2009 to split the roles. Five years later, the board voted without shareholder approval to recombine them. The unilateral about-face ignited a media firestorm and prompted analysts and commentators to ask whether these roles should ever be combined.

The theoretical answer to this question is: No. “The purpose of the board is to oversee the executives,” says Charles Elson, director of the John L. Weinberg Center for Corporate Governance at the University of Delaware. “You defeat this purpose when the head of the board is also an executive.”

This oversight function is important for banks in particular, given their need to balance revenue growth against robust risk management. “When the economy is strong and growing, many bank CEOs are inclined to take more risk than they should,” explains Eric Fischer, senior fellow at Boston University and former general counsel at what is now known as U.S. Trust. “And when the economy takes a turn for the worse, they’re likely to be more risk adverse than the situation calls for.”

At least in theory, then, installing an independent chairman isn’t only smart from a corporate governance perspective, it also helps a bank operate countercyclically-one of the most important but difficult tasks banks face.

Unfortunately, the problem lies in proving a CEO/chairman split benefits the bottom line. Academic studies don’t link the so-called “CEO duality” to a company’s performance.

The closest researchers have come is a 2012 study by Matthew Semadeni and Ryan Krause, professors at Arizona State University and Texas Christian University, respectively. After analyzing 309 instances where S&P 1500 companies split the roles from 2003 to 2005, Semadeni and Krause found that doing so promoted strong future performance only when it followed weak past performance, and only when the CEO stayed the same but a new chairman was appointed.

“The lesson is that context matters,” says Krause. “There’s a lot of pressure on boards to adopt certain governance practices based on ideology or principle alone, but this is a mistake. In other aspects of management we acknowledge that companies face unique challenges; this issue is no different.”

An increasingly popular alternative to splitting the roles is to nominate a lead independent director who has enhanced powers but remains subordinate to the chairman. Executive recruiting firm Spencer Stuart estimated that 90 percent of companies on the S&P 500 had a lead or presiding director in 2014. Only three of the companies it queried did not report some type of independent board leadership-either an independent chairman or a lead or presiding director.

But measurable benefits have eluded researchers here as well, fueling indifference among some observers about whether the roles should be split in the first place. “Over the last 50 years, I have dealt literally with thousands of investors,” says bank analyst Richard Bove of Rafferty Capital Markets. “Not one ever indicated that they would buy or sell a given bank stock over the issue as to whether the CEO/chairman positions should be kept together or split.”

Given this, the only honest answer to the question of whether it’s best to split the roles of chairman and CEO is that we don’t know. Organizational theory offers a strong case that it’s best to do so, but tangible evidence that it impacts future performance remains to be seen.

Does board diversity promote better financial performance?
Unlike the elusive impact of CEO duality, a growing number of studies claim to have identified a statistically significant link between diversity on a company’s board of directors and profitability.

A widely cited 2007 report by Catalyst, a nonprofit organization with offices around the world, split Fortune 500 companies into quartiles based on the percentage of women on their boards. It then compared those quartiles to financial performance. Catalyst found that companies in the highest quartile of female board representation generated an average return on equity of 13.9 percent from 2001 to 2004. Companies in the lowest quartile, meanwhile, returned an average of only 9.1 percent.

A more recent study by Zurich-based Credit Suisse Group reached a similar conclusion after looking at the board structures and senior management of more than 3,000 companies from the beginning of 2012 through the middle of 2014. Those with market capitalizations of at least $10 billion and with at least one woman on the board outperformed their similarly sized counterparts by an average 5 percent. The same relationship was true at smaller companies, though the margin of outperformance was 2.5 percent.

To be clear, other researchers have found either no statistically significant relationship between gender diversity and performance or, in some cases, even a negative correlation. This ambiguity is magnified, moreover, when racial or ethnic diversity is examined, both of which have received less attention from academics seeking to link board diversity to profitability. Stanford University professors Deborah Rhode and Amanda Packel, in a 2014 paper, reviewed the research linking board diversity to corporate performance and found the results were mixed, possibly because of differences in methodology.

Despite this conflicting precedent, the argument in favor of diversity is growing stronger every day.

Banks are no longer limited to serving the communities in their immediate geographic vicinities. Online banking and mobile applications from third-party vendors like Moven, as well as partnerships with online lenders such as Lending Club, now allow community and regional banks to reach broader and more diverse consumer groups.

“To attract and serve these customers effectively,” says Fischer, “a bank’s board needs to be fairly representative of the community.”

On top of this, directors with varied experiences and backgrounds bring unique insights to the table. Female directors are believed to improve the a board’s problem-solving and decision-making ability, a 1997 study found. Six years later, a separate analysis concluded that women take their board responsibilities more seriously and tend to come to meetings better prepared than men.

The point is that a widely diverse board of directors isn’t just good for public relations, it also seems to be good for business.


John Maxfield


John Maxfield is a freelance writer for Bank Director magazine. He was previously the senior banking specialist at The Motley Fool. He regularly writes for Bank Director magazine and BankDirector.com. His work has been syndicated widely to national publications including USA Today, Time and Business Insider, and he’s been a regular guest on CNBC. John has a bachelor’s degree in economics from Lewis & Clark College and a juris doctorate from Southern Methodist University. He’s a licensed attorney in the State of Oregon.

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