Board independence protects firms from corporate misconduct

The more a company's board is independent from management, the less likely it will become entangled in corporate misconduct, according to new findings, from a meta-analysis of 135 studies, published in The Journal of Management. The site of independence also matters. Independence on the audit committee particularly shelters firms from misconduct, researchers found. At the same time, accepted levels of corruption in countries where firms are located can overpower the effects of board independence on misconduct.

The study is the first to evaluate the link between board independence and misconduct worldwide, and to compare the effectiveness of three different "sites" of independence: the board overall, the audit committee and CEO-chair separation, said Corinne Post, professor of management at Lehigh University. Post co-authored the paper "Board Independence and Corporate Misconduct: A Cross-National Meta-Analysis" with Andrew Ward of Lehigh University and lead authors François Neville of McMaster University and Kris Byron of Georgia State University. The study is the first to meta-analyze the relationship between board independence and misconduct.

"Examining board independence in relation to misconduct is important, given the far-reaching negative consequences of misconduct," the researchers said. "Corporate misconduct damages firm reputation, increases employee turnover, harms customers and other stakeholders, and ultimately incurs losses for shareholders."

Independence to curb misconduct

Board independence is a commonly offered solution to curbing corporate misconduct. In the wake of the global financial crisis and high-profile corporate scandals at firms such as Siemens, Enron, Toshiba, Olympus and WorldCom, practitioners and policy makers have looked to increased board independence as a governance mechanism to deter misconduct. A lack of board independence is considered a key contributing factor to the Volkswagen emissions scandal.

Thus, many countries have adopted rules about board independence. For example, India, Hungary, Korea and the United States require that boards be primarily composed of independent directors, and Japan requires companies with no independent directors to justify why appointing one is not appropriate. Other countries, however, such as New Zealand and Luxembourg, have minimal or no independence requirements.

The notion that board independence is synonymous with good governance and can help curb corporate misconduct reflects an established view that independent directors are better positioned to impartially and dispassionately monitor firm managers and their policies and to curb any opportunistic management behavior.

"Overall, independent directors, as compared to inside or affiliated directors, are expected to be more vigilant in their efforts to identify and snuff out corporate misconduct because, compared to inside or affiliated directors, they are more able to focus on the firm's operational, financial and strategic irregularities and more motivated to monitor and curb misconduct to protect their personal reputations," the researchers said.

Increasingly, however, some scholars are questioning whether board independence is an adequate solution to the problem of corporate misconduct. For example, barriers such as outside job demands and norms of deference can prevent independent directors from being effective monitors.

"Because the empirical evidence is mixed, we set out to draw on the universe of studies and available data to settle the question," Post said. The researchers identified all existing studies on board independence and organizational misconduct, conducting a meta-analysis of 135 studies representing almost 80,000 firms in more than 20 countries.