UK corporate governance reforms have adopted a particular view about senior executives that is consistent with Agency Theory. This theory, used in economics, views individuals as seeking to maximise their own wealth—even if this involves deceit or comes at the expense of others.
Under the assumptions of Agency Theory, managers should be closely monitored and properly financially incentivised if they are to be expected to perform well.
Accordingly, UK corporate governance codes have progressively introduced greater monitoring of top executives, along with encouraging the use of financial incentives to encourage managers to work harder in the interests of shareholders.
However, after more than 20 years of research in the area, academics have failed to find consistent evidence that the adoption of various code recommendations is associated with an improvement to firms’ performance.
One explanation for this is that managers are actually not selfish wealth-maximisers who need strict monitoring and performance-related rewards in order to motivate them.
An alternative view of managerial motivation is one proposed by Stewardship Theory. Adopting a different psychological approach to that of Agency Theory, Stewardship Theory argues that managerial behaviour is shaped by an intrinsic desire for achievement and responsibility; this may be reinforced by a positive relationship with the organisation, such as a long career with the same company.
Under Stewardship Theory, the manager is inherently motivated and derives utility from the competent performance of his or her job. Thus, extra monitoring or strong extrinsic motivators such as bonus payments or share options confer no benefits to shareholders.
As a specific example, there is little to be gained by insisting on an independent chairman of the board, a measure introduced by the Combined Code 2003.
Proponents of Agency Theory would argue that an independent chairman will provide better board oversight and monitoring of the incoming chief executive officers. Those who see top managers as stewards rather than agents would argue that allowing the CEO to remain as chairman is evidence of an orderly succession process that is unlikely to harm the firm.
I tested these opposing views in a recent academic paper in the British Accounting Review. For the study, I analysed a set of 225 routine CEO (i.e. retirement) departures which took place in the years around the reform, from 1996 to 2007.
I looked for evidence that allowing the CEO to remain as chairman of the board had any detrimental effect on company performance by comparing the post-departure performance of these companies with that of companies where the CEO left the board upon retirement.
I found no evidence that allowing the CEO to remain as chairman of the board causes any detriment either to stock market or accounting performance for at least the two years following the handover of power.
It appears that companies were perfectly able to select appropriate succession practices without regulatory intervention.
It is therefore perhaps unfortunate that I found the 2003 Code had caused companies to alter their succession processes, with many fewer companies allowing their CEOs to remain as chairman upon their retirement from executive duties in the period following the Code.
Of the 134 CEOs retiring prior to 2003, 81 (60%) had remained as chairman of the board; of the 91 post-2003 retirements, in only 34 (37%) cases was the CEO retained as chairman, with the board sacrificing an abundance of specialist knowledge of the company in favour of an independent appointment and, of course, Code compliance.
Although this study addresses only one of the many board reforms imposed by the various committees since the Cadbury Committee in 1992, it serves to highlight a general problem with UK corporate governance reform—the failure to review the effectiveness of any reforms.
Without effective ex-post, evidence-based reviews, it is impossible to ascertain whether the costs imposed upon companies by governance reforms yield any benefits to shareholders.
Committee after committee has extended the requirements companies must meet in order to be able to tick the box saying they comply with best practice.
Has any committee rescinded previous reforms because they are ineffective and therefore a pointless burden to companies?
It is a struggle to bring any such occurrences to mind. CEO succession is an important issue which was already difficult to manage before the Higgs committee reduced the options available to firms. Complying with board independence criteria in general is costly. Is it worth it? We simply don’t know.