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Boardroom issues caused by 'herd effect'

Date: 02 Jun 2009

Publication: Sunday Tribune Business

Author: Professor Niamh Brennan

The hue and cry about corporate governance following the worldwide meltdown of our financial institutions reminds me of the reaction to the Enron crisis. After Enron, a slew of corporate governance weaknesses emerged, leading to draconian legislation in the US in the form of the Sarbanes Oxley Act. There was a feeling that big corporate collapses could no longer happen. This legislation applies to Irish banks quoted in the US such as AIB and Bank of Ireland. Where was 'SarbOx' in the current crisis?

Can regulation prevent corporate collapses and corporate governance failures in the future? This is akin to asking can legislation prevent murder. As long as we have human beings, we will on occasion have dysfunctional behaviour (both intentional and unintentional). In the final analysis, no laws, no rules, no regulations can prevent misjudgement, greed, fraud, theft, etc. by company directors. All they can do is make such behaviour more difficult to engage in.

Two key corporate governance mechanisms are corporate boards of directors and external auditors. These two mechanisms share a common approach. They involve one group of people (non-executive directors/external auditors) overseeing and checking up on another group of people, executive directors and senior managers. However, given human weaknesses, corporate history is replete with examples of failures of both these mechanisms, reliant as they are on human behaviour.

There is no doubt that boards and non-executive directors could have performed better and could have prevented some of the excesses. But we have to go back to basics and critically examine how people get on to boards in the first place. Is it because they are awkward types, individualistic, likely to ask critical questions in the boardroom? Or is it because they are team players, easy to get on with? With the team player model, there is a risk of a 'herd effect'.

Many people believe it is not possible to recruit truly independent directors given Ireland's small size. I do not accept this argument. If the net is cast wide enough, there are excellent professionals in Irish business capable of being independent non-executive directors. It is not so much about the size of the pool of available non-executive directors, rather it is about the availability of independent-minded individuals who are willing to stand apart from fellow directors and dissent from majority views.

The government has appointed 'public interest' directors to the financial institutions. Are these public interest directors better than any other groups of directors? I suspect not. Are directors appointed by government a better group of people than non-government, private-sector directors? I suspect not, especially if one looks at the performance of some state boards.

There are 'red flags' to which we should pay more attention.

Excessive power in a single individual
CEO-board capture: Does the CEO run the board, or does the board oversee the CEO?
Information asymmetry: Boards are only as good as the information made available to them. Are executive directors gatekeepers of information? Do they withhold key information?
Minority views: Does the board listen to the minority voice? There were minority voices expressing concerns for a number of years coming up to the credit crunch. Were these minority voices listened to or were they accused of being disloyal? In the memorable words of Bertie Ahern: "Sitting on the sidelines, cribbling and moaning is a lost opportunity. I don't know how people who engage in that don't commit suicide." We should learn to listen carefully to minority views, and test our models, assumptions and accepted views of the world for the possibility that we might be wrong, and they might be right.
Extreme corporate successes: Success so good that it is too good to be true. If it is too good to be true, then maybe it isn't true.
Huge pay: Earning excessive pay - immoral sums of money - encourages extreme human behaviour.

Directors are required to look after the long-term best interests of their companies. A focus on non-monetary performance and on performance in the medium to long term is less likely to result in extreme (and risky) behaviour. One of Ireland's most successful private companies has as its core value 'don't be greedy'. Other companies - please copy!

Niamh Brennan is Michael MacCormac Professor of Management and Academic Director of the Centre for Corporate Governance at UCD.

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Boardroom issues caused by 'herd effect'

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