In the US, in the 1980s, shareholders (especially institutional investors) began to advocate that company directors should take certain measures that restrict top managers from having a ball at shareholders’ expense; that is, undertake strategic actions that are in their own interest but not in those of the company’s shareholders. Yet, after making some initial in-roads, two decades later, this reform process has stagnated. For example, the portion of large US companies with an independent board chair or an independent nominating committee for new board members (two of the things advocated by the investors) was only slightly higher in 1999 than in 1989.
How come? Why has this governance reform stagnated? To answer this question, Professor James Westphal – currently at the University of Michigan – conducted an elaborate study. He collected data on 417 firms, interviewed scores of top managers and directors, obtained surveys from no less than 1098 directors and 197 CEOs at multiple points in time, and came up with an intriguing answer.
He found that the top managers and board members of the US’s biggest companies together form an “elite”, which act very much like “the clique of popular kids in high-school”. Let me explain.
Specifically, Jim tracked directors’ voting behaviour when any of the following four measures were being proposed in the company (which each limit top managers’ power):
- CEOs can not concurrently also hold the seat of chairman of the board (so that the board can operate independently)
- The company should have a nominating committee to appoint new board members, rather than that the company’s CEO controls this process
- The director at some point had voted to dismiss the (underperforming) company’s CEO (a measure clearly not in the interest of the CEO!)
- The company should revoke a so-called poison pill construction – a mechanism that makes it difficult for a firm to be acquired against top management’s will (so that even when top management is doing a poor job, and the company is underperforming, they still can’t be ousted by new owners)
Then, Jim examined what had happened to the directors that had voted in favour of adopting one or more of these ("controversial") measures…
First, what you have to realise, is that people who hold board memberships more often than not also are members of the boards of other companies. If a particular board member, at some point in time, had voted for one of the above measures, which remove privileges away from top managers (i.e. members of the elite) and give it to investors (who are not considered part of the elite), their fellow directors at other boards would subsequently start to give them the cold shoulder. The board member would become unpopular with the rest of the in-crowd, and get treated as “a traitor”.
The questionnaires and interviews (conducted with both the "unpopular board members" themselves as well as with their "friends") clearly indicated that the other boards’ members would start to engage in subtle behaviour intended to punish the deviant person, such as neglecting to invite him to informal meetings, not asking his opinion or advice in formal meetings, not acknowledging or building on his comments in discussion, engaging in exclusionary gossip whereby they would talk about other people and events with which the director was not familiar, etc.
For example, interviewed board members said that the deviant persons “can expect to be ostracized”, “people are less interested in working with them”. One director said, “The directors [who had voted for one of the four changes] get treated differently – I think they get put on notice a bit”, while another commented, “it will hurt you. You won’t get thrown off the board, but you definitely won’t get treated the same. In a way you get treated like the enemy – or at least as suspect”. One director, who had once voted in favour of one of the measures, related his own experience: “after we fired the CEO I got the cold shoulder from colleagues at another board… I didn’t get invited to an important meeting”.
Does this perhaps remind you of your high school days...?
And, guess what, it worked. Jim, in his statistical analysis, also examined what the subsequent voting behaviour was of the directors who had been subject to such treatment. Whenever, in the ensuing years, there would be another vote about one of the four aforementioned measures, the directors would cave in, and vote against it. They didn’t dare do it again.