Why outside directors

Presidents and other members of top management in describing the discipline value of boards, indicated that the requirement of appearing formally before a board of directors consisting of respected, able people of stature, no matter how friendly, motivates the company managers to do a better job of thinking through their problems and of being prepared with solutions, explanations, or rationales.

There is a discipline factor here. We go to a lot of trouble to make sure that what we present to the board is well thought through and an attractively presented proposal—we want to manifest that the proposal is a product of thoughtful management. But I think we behave differently internally, knowing that we have outside directors. The mere existence of outside directors makes us think a little bit harder, makes us organize our thoughts. It sharpens up the whole organization.

The discipline value of boards also serves as an administrative device for presidents to use in establishing standards of performance for work done by subordinates. For example, with capital appropriations on the agenda for the next board meeting, many presidents remind functional or divisional managers that market and financial justifications have to be carefully organized and documented so that there will be no possibility of embarrassing questions from board members.

If management did not have this requirement, I wonder what the ceiling or limits would be on what management might do. The conscience role of the board is a device that makes sure that homework is being done, and that criteria are thought through and proposed.

The conscience function is involved in capital appropriations, operating budgets, compensation decisions, and others. Usually, the symbols of corporate conscience are more apparent than real, and presidents with complete powers of control make the compensation policies and decisions. The compensation committee, and the board which approves the recommendations of the committee, are not decision-making bodies.

These decisions are made by the president, and the committee and board approval is perfunctory. The president has de facto powers of control, and in most cases he is the decision maker. The board does, I believe, tend to temper the inclinations of presidents with de facto control, and it does contribute to the avoidance of excesses.

Thus it serves the important role of a corporate conscience. There are two critical states of corporate affairs in which the role of the board of directors is more than advisory. First, if the president dies suddenly or becomes incapacitated, the board has the decision-making responsibility to select his successor.

Only when confronted with the unexpected death of the president have they been propelled into a decision-making function. But the board is there—and it is legally constituted to pick a successor and to ensure the continuity of an entity organized to operate in perpetuity. The drama and trauma that develop when a board of directors has thrust upon it unexpectedly the complete de facto powers of control were illustrated during many of my field research interviews.

The dynamics of the assumption of all or part of the de facto powers of control by individual directors and combines of directors, in these situations, is worthy in my judgment of a separate study. Second, if the leadership and performance of the president are so unsatisfactory that a change must be made, the board of directors performs a decision-making role: here, the president is asked to resign—an important decision; and then the board must decide on his successor—an equally important decision.

I have concluded that generally boards of directors do not do an effective job of evaluating or measuring the performance of the president. Rarely are standards or criteria established and agreed upon by which the president can be measured other than by the usual general test of corporate profitability; and it is surprising how slow some directors are to respond to years of steadily declining profitability.

Since directors are selected by the president, and group and individual loyalties have been developed through working together, directors are reluctant to measure the executive performance of the president carefully against specific standards. Directors base their appraisals largely on data and reports provided by the president himself.

Also, top executives serving as outside directors, and being exceedingly busy men, typically do not devote time to pursue through further inquiry any concerns they may deduce from the data presented to them as directors, even when the concern might extend to the performance of the president.

In those situations where mounting and persuasive evidence leads individual directors or groups of directors to a conclusion that the president is unsatisfactory, I have found that one of three courses of action is usually followed:. Periodic management audits by consulting firms appear to be increasingly common and accepted by top executives even in highly successful enterprises.

This is the most common and typical response of directors who suspect or conclude that the president is unsatisfactory. Resignation from boards for a plausible reason, such as conflict of interest, enables a director to avoid facing the ultimate and inevitably unpleasant task of acting to replace a president.

In addition, with public disclosure of an apparently reasonable basis for a resignation, typically there is no embarrassment to the company or to the believed-to-be-inadequate president. Most boards of directors and most individual directors are intensely reluctant to face the unpleasant conclusion that the president of the company must be replaced.

While sometimes the unpleasantness is avoided by hiring outside consultants or by resigning from the board, there are some situations in which board members who have procrastinated in taking any action find themselves obligated to face the task of asking the president to resign. These situations are relatively rare. For the most part, the outside directors remained on the board and devoted more than casual amounts of time to the company in distress.

Many directors expressed regret for not having responded to the symptoms of weakness they had seen earlier, now more recognizable than before. They gave more of their time to the affairs of the ailing company, and they acted as responsible corporate citizens by assuming for the interim the de facto powers of control held previously by the president.

The business literature describing the classic functions of boards of directors typically includes three important roles: a establishing basic objectives, corporate strategies, and broad policies; b asking discerning questions; and c selecting the president. In this section of the article, I shall discuss the evidence that I collected during my interviews on each of these generally accepted roles. Boards of directors of most large and mediumsized companies do not establish objectives, strategies, and policies, however defined.

These roles are performed by company managements. Presidents and outside directors generally are agreed that only management can, and should have, these responsibilities. We decide what course we are going to paddle our canoe in.

We tell our directors the direction of the company and the reasons for it. Theoretically, the board has a right of veto, but they never exercise it. Naturally, we consult with them if we are making a major change in direction. We communicate with them. But they are in no position to challenge what we propose to do. And the market, for more and more companies, includes opportunities abroad, thus adding another complicating dimension of analysis.

The typical outside director does not have time to make the kinds of studies needed to establish company objectives and strategies. At most, he can approve positions taken by management—and this approval is based on scanty facts, not on time-consuming analysis.

Giving operational meaning to a set of defined corporate objectives is generally achieved by allocating or reallocating corporate capital resources. The managements of a few companies, I found, do not accept the idea that boards can, or should be, involved in the process of capital appropriations, even in an advisory capacity.

Accordingly, their studies and approvals of capital appropriations are made at management levels and not at the level of the board of directors. In most companies, the allocation of capital resources, including the acquisition of other enterprises, is accomplished through a management process of analysis resulting in recommendations to the board and in requests for approval by the board. The minimum dollar amounts which require board approval and the quantity of analytical supporting data accompanying such requests vary among companies.

Approval by boards in most companies is perfunctory, automatic, and routine. Presidents and their subordinates, deeply involved in analysis and decision making prior to presentation to the board, believe in the correctness of their recommendations, and—almost without exception—these go unchallenged by members of the board. Rarely do boards go contrary to the wishes of the president. In a few instances, boards of directors do establish objectives, strategies, and major policies, but these are exceptions.

Here, the president wants the involvement of the directors, and he not only allows for, but insists on, full discussion, exploration of the issues, agreement, and decisions by the board along with himself.

A second classic role ascribed to boards of directors is that of asking discerning questions—inside and outside the board meetings. Again, I found that directors do not in fact do this. Board meetings are not regarded as proper forums for discussions arising out of questions asked by board members; the president and directors alike feel that such meetings are not intended as debating societies.

In one situation, for example, an outside director, who was concerned about steadily declining earnings and who perceived no apparent management program to reverse the trend, asked the chairman and the president what was being done to correct the situation. The other outside directors also expressed their concern, and the president, obviously embarrassed, responded with unpersuasive and unimpressive replies.

After the meeting, the chairman asked the initial questioner to stop by his office before leaving, and there he explained:. You must remember that you are challenging the president in the presence of his subordinates, some of who are insiders on the board. If you have questions about what is being done to reverse the trend, the proper way is to make a date to confer with the president privately. Presidents generally do not want to be challenged by the questions of directors, especially if subordinates of the president are on the board or in attendance at the meeting.

Despite the fact that most presidents profess that they want questions to be asked by interested members of the board, I have concluded that, while they may say this, and may even go to some trouble to make directors feel that they are free to question, actually the presidents do not want discerning questions or comments.

The unsophisticated director may learn from experiencing rebuffs that the president does not want penetrating and issue-provoking questions, but only those which are gentle and supportive and an affirmation that the board approves of him. Many presidents stated that board members should manifest by their queries, if any, that they approve of the management.

If a director feels that he has any basis for doubt and disapproval, most of the presidents interviewed believe that he should resign. The lack of active discussion of major issues at typical board meetings and the absence of discerning questions by board members result in most board meetings resembling the performance of traditional and well-established, almost religious, rituals. In most companies, it would be possible to write the minutes of a board meeting in advance. The format is always the same, and the behavior and involvement of directors are completely predictable—only the financial figures are different.

My research disclosed few exceptions to this routine. In a handful of instances, presidents said that they do in fact want discerning, challenging questions and active discussions of important issues at their board meetings. There are also a few directors who do in fact ask discerning questions, the desires of the president notwithstanding.

Typical garden-variety outside directors, selected by the president and generally members of a peer group, do not ask questions inside or outside board meetings. However, directors who serve on corporate boards of companies because they own or represent the ownership of substantial shares of stock generally do in fact ask discerning questions. An outside director is otherwise called a non-executive director.

In the United States, there are certain corporate governance standards that stipulate that outside directors must be present on the board of directors of every company.

In the U. There are many benefits of having outside directors on a company's board of directors, these include;.

Despite the advantages outside directors bring to a company, there are some downsides of these directors such as lack of adequate incentive, insufficient information about the company, lack of access to classified information, among others. Outside directors play important roles in companies, this is why all companies must have a number of these directors on their boards. It is the duty of these directors to maintain their positions and also contribute to the growth and success of the company.

Typically, outside directors help keep companies in check by performing oversight or checks and balances functions. In the case of Enron however, the outside directors of Enron derailed from their duties, enabling Andrew S. Fastow, a one time CEO of the company to enter shady deals that cause chaise for the firm. Outside directors faced out-of-pocket liability from the judgments and settlement that resulted from the deals. There are corporate governance standards and guidelines hat outside directors must adhere to, these guidelines will not only keep their companies in check but also help prevent frauds and shady deals by top executives or inside directors of the companies.

Corporate governance contains clear policies that reduce risks and liabilities that a company and its directors are exposed to, these policies create a balance between the operations of a company and help in attaining its goals and objectives. It is essential that outside directors use corporate governance rules as measures of controlling their organizations. Written by Jason Gordon Updated at September 25th, Contact Us If you still have questions or prefer to get help directly from an agent, please submit a request.

Please fill out the contact form below and we will reply as soon as possible. Academic Research Corporate governance and the role of non - executive directors in large UK companies: an empirical study , Pass, C. Corporate Governance: The international journal of business in society , 4 2 , This paper studies corporate governance structures in the UK and scrutinizes the role played by non-executive directors in fostering best business practices.

The Higgs Committee was appointed to reevaluate the role of non-executive directors as a measure to determine whether companies were still conforming to best practice recommendations and if financial irregularities were taking place.

The contribution of non - executive directors to the effectiveness of corporate governance , Clarke, T. Career Development International , 3 3 , This paper scrutinizes the role of non-executive directors while emphasizing that it is in a companys best interest to have outsiders in its board of directors. It also argues that shareholders cannot be considered viable counterforces to limit misuse of power by the board of directors. Create a personalised ads profile. Select personalised ads.

Apply market research to generate audience insights. Measure content performance. Develop and improve products. List of Partners vendors. An outside director is a member of a company's board of directors who is not an employee or stakeholder in the company. Corporate governance standards require public companies to have a certain number or percentage of outside directors on their boards. An outside director is also referred to as a " non-executive director. In theory, outside directors are advantageous for the company because they have less conflict of interest and may see the big picture differently than insiders.

The downside of outside directors is that since they are less involved with the companies they represent, they may have less information upon which to base decisions and fewer incentives to perform. Also, outside directors can face out-of-pocket liability if a judgment or settlement occurs that is not completely covered by the company or its insurance.

This occurred in class-action suits against Enron and WorldCom. Board members with direct ties to the company are called "inside directors. Outside directors have an important responsibility to uphold their positions with integrity and protect and help grow shareholder wealth.

Fastow to enter into deals that created a significant conflict of interest with shareholders as he concocted a plan to make the company appear to be on solid financial footing, despite the fact that many of its subsidiaries were losing money. Corporate governance is a comprehensive system of rules that control and direct a company. These protocol balance the interests of a company's many stakeholders, including shareholders, management, customers, suppliers, financiers, government and the community.

They also help a company attain its objectives, offering action plans and internal controls for performance measurement and corporate disclosure. Stanford Law Review. Securities and Exchange Commission.