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A CORPORATE CATCH-22

Flexibility is key in helping companies test new governance practices.

corporate boardroom

PHOTO BY GETTY IMAGES | ASBE

 

Leadership today is complicated as companies face issues well beyond what they make or sell, including climate change, income inequality, and racial and ethnic diversity.

Boards of directors work alongside top management, but they’re also responsible for overseeing the CEO, approving executive compensation and setting strategy.

Yet innovations in corporate governance — practices that dictate how boards lead and monitor companies — have a dismal track record.

Ryan Krause

Ryan Krause, associate professor of strategy in TCU’s Neeley School of Business.

Ryan Krause, associate professor of strategy in TCU’s Neeley School of Business and the Robert and Edith Schumacher Junior Faculty Fellow in Entrepreneurship and Innovation, wanted to know why.

He argues in the paper “Innovation in the Boardroom,” published last May in the Academy of Management Perspectives, that new ideas in corporate governance must be seen as legitimate from the start. But because innovations are untested and not widely accepted, they’re “inherently illegitimate,” which means they often fail.

Krause and co-author Matthew Semadeni, professor of strategy at Arizona State University’s W.P. Carey School of Business, found that failure to achieve multiple forms of legitimacy leads to disputes and limited adoption of an innovation. The more types of legitimacies garnered, the more likely an innovation will be embraced.

“No one wants to be the first adopter,” Krause said in a Zoom interview from Denmark, where he was on a research sabbatical in fall 2020. “Companies often fall back on the rationale of ‘This is how it’s been done’ or ‘This is best practice’ because it gives them legitimacy.”

Krause and Semadeni analyzed three recent corporate governance innovations — majority voting, say-on-pay voting and the appointment of lead independent directors — based on three types of legitimacies: pragmatic (responding to a need), moral (socially acceptable) and cognitive (necessary or inevitable).

They identified the lead independent director as a successful corporate governance practice. That’s partly because it’s a “compromise solution,” Krause said, which lets a CEO remain as board chair and adds another director to provide oversight and monitoring.

This arrangement dates to the 1990s, but it didn’t gain favor until after the Enron and WorldCom scandals of the early 2000s and the Sarbanes-Oxley Act, which mandated financial and corporate governance improvements. The appointment of lead independent directors eventually spread because it met all three legitimacies, Krause said.

In comparison, requiring a director to receive a majority of shareholder votes to be elected and giving shareholders a say on executive compensation haven’t been as successful.

Nearly 90 percent of Standard & Poor’s 500 companies use majority voting in some form, but most smaller companies do not. Although majority voting has been rapidly adopted, gaining cognitive and pragmatic legitimacy, it has low moral legitimacy, Krause said. Adopted mostly on an advisory basis, it has produced little change, he added.

Many corporate governance practices have focused on executive compensation. The average-CEO-to-average-worker pay ratio was 278 to 1 in 2018, according to the Economic Policy Institute.

To provide shareholders with a greater voice in executive pay, federal legislation now mandates say-on-pay voting for publicly traded companies on an advisory basis. In the past decade, some shareholders have rejected executive pay packages, including at drug company McKesson and financial giant Citigroup.

But Krause said the nonbinding votes appear to have little effect even though many corners see say-on-pay voting as crucial.

Previous research by Krause and Semadeni showed shareholders care about high CEO pay only at poorly performing companies, which makes it unclear if a no vote means shareholders are angry with the CEO or the board, Semadeni said.

“The big takeaway is to allow for more flexibility to allow these firms to innovate,” said Semadeni, who has collaborated with Krause on governance research for a decade. “Most of these measures have failed or not achieved what they wanted to do.”

Flexibility is needed, he and Krause concluded, so companies can experiment with new corporate governance practices without having to permanently adopt them.

Sometimes current events, such as the coronavirus pandemic, accelerate change.

Covid-19 brought a “seismic shift” to companies that perhaps for the first time had to think about their survival, Krause said. Boards had to become “more active and accessible.”

Now Krause, who won TCU’s 2019 Deans’ Award for Research and Creativity, is focusing his research on board leadership. “The board chair role is incredibly complex and murky,” he said. “I hope to contribute to understanding how they lead and how to best execute this incredibly weird job.”

BY SHERYL JEAN