Definition of board composition

Board composition normally concerns issues related to board independence (including independence of board committees), diversity (firm and industry experience, functional backgrounds, etc) of board members, and CEO duality.

In general, directors can be classified into three categories.

Insider directors or management directors are salaried employees, such as the CEO, president, CFO or COO.

Related or affiliated outside directors are those who have a pre-existing relationship with the firm, such as family relatives and retired executives.

Independent outside directors are directors who have no personal connections or business dealing with the firm.

Taken together, board independence refers to a corporate board that has a majority of independent outside directors. Compared to an insider-dominated board, an outsider-dominated board is believed to be more vigilant in monitoring managerial behaviors and decision-making of the firm.

However, having an independent board alone may not be sufficient to guarantee good governance control. It is likely that some independent board members might be brought in to serve as tokens or window dressing in order to fulfil the minimum regulatory requirements. Moreover, outside directors might not be truly independent from firm executives if they feel indebted to the CEO who hired them or have developed strong friendship with the top management at the focal firm over the years they have served on the board.

In addition, a board that consists of directors with a diverse set of functional expertise (marketing, engineering, finance, etc) industry experiences, educational qualifications, ethnic and gender mix might be better equipped to deal with a wide range of issues facing the firm and provide executives with advice and consultation from multiple perspectives.

 Another issue related to board composition is whether a CEO also serves as a chairman on the company board (so-called CEO duality). Although CEO duality has its merits and could be desirable in some conditions, the fact is that a CEO holding dual positions in the firm suggests a strong, powerful leader with a great control over firm decision-making, which in turn, might weaken the board’s governance role as a management watchdog.  Under such circumstances, setting up a lead director role among outside directors can effectively balance the power of a CEO and other insiders.

Example

Although backgrounds and experiences of directors can convey basic qualifications of corporate board members, such information is not sufficient to determine a board’s level of vigilance in its oversight role. A notorious example would be the governance failure of Enron’s board, which was composed of mostly financially sophisticated figures with elite social status and Ivy League education. Ironically, Enron’s board was named one of the top five boards in 2000 by Chief Executive Magazine, one year before the firm collapsed. [1] 

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