Boards of Directors: Surprising New Study Reveals Their Real Role

Although Elon Musk fired Twitter’s board of directors and replaced them with himself upon closing his $44 billion takeover deal, the social media giant isn’t the only company all over the news recently that’s operating with only a single-member board. Another is FTX, the $32 billion crypto derivatives exchange that imploded spectacularly in a November 2022 bankruptcy filing. And a third is The Block, the crypto news outlet that secretly accepted a $43 million payoff from FTX’s CEO Sam Bankman-Fried.

Many observers become alarmed not only when they notice absent boards of directors like these, but also when they recognize boards that permit or fail to preclude misdeeds by their firm’s senior executives. For example, the board at Enron was assailed by Congress for condoning actions by executives that resulted in the bankruptcy of the largest public company in history. Similarly attacked were the boards at Theranos—whose CEO Elizabeth Holmes was recently sentenced to prison for defrauding investors—and at Boeing after the 737 MAX plane crashes.

Why all this concern? Along with most MBA students, most of us—including elected officials, regulators, academic experts, the press, and the public—all believe that a firm’s board of directors functions as society’s principal entity charged with holding chief executives accountable.

However, surprising new research reveals that board members do not perceive this to be their role.

The Study: What is the Perceived Role of Company Boards of Directors?

This study was conducted by a team of four business school management professors. The scholars included Dr. Steve Boivie and Dr. Michael Withers at Texas A&M University’s Mays Business School, Dr. Scott Graffin of the University of Georgia’s Terry College of Business, and Dr. Kevin Corley at Arizona State University’s W.P. Carey School of Business. Entitled “Corporate Directors’ Implicit Theories of the Roles and Duties of Boards,” their paper was published in the September 2021 edition of the Strategic Management Journal.

Spanning a year for interviews and analysis, this team’s work appears to be the most extensive data collection effort in more than three decades among United States corporate boards. The 48 corporate directors interviewed for this study represent more than 140 different companies in a wide variety of industries, with some interviewees having logged nearly 30 years of experience serving on boards.

The professors selected these board members for interviews because their business schools had established prior relationships with them extending back several years. Usually, these relationships developed out of executive MBA and other kinds of educational, research, and consulting programs that their companies had purchased from these universities.

The Disconnect Between Directors’ Views and Legal Requirements

The team sought to answer two primary research questions:

1. How do directors view the roles and duties of a board?
2. How do those views affect how the directors act?

The team’s surprising finding was that directors do not believe their main job is to monitor executives. Instead, most of the board members told the team that they believed their principal function was to support executives by collaborating with them as strategic partners.

This finding is so remarkable because it illustrates a profound disconnect between how most directors view their jobs, compared with laws and regulations that attempt to mandate directors to act as overseers who hold chief executives accountable. Most of these legal requirements evolved out of an obscure branch of economics known as agency theory.

Briefly, economists apply agency theory to explain issues that arise within the relationship between business principals—such as shareholders—and their agents, who are company executives. These agents make decisions on behalf of the principals, who have little to no input on a day-to-day basis in how the agents manage the business.

At the same time, the executives (or agents) are exposed to little to no financial risk because losses would end up shouldered by the principals. This misalignment of interests is typically called the principal-agent problem.

Executive agents often have little to no investment in the business when compared with the much larger scale of investments by the shareholder principals. Accordingly, regulations and laws based on this theory attempt to protect the shareholders from exploitation by decisions that the managers make based solely on their own interests, instead of decisions made in the best interests of the shareholders they have been hired to serve.

Legal requirements drafted to curb such abuses typically mandate that the directors closely monitor and vote to approve or deny proposals bearing broad strategic importance to the company’s future. Regulators and elected officials drafted such mandates because the economists who created agency theory assumed that those should be the alternatives a reasonable board member should choose while carrying out their role.

For example, that’s the kind of director’s role drafted into the most recent federal statute governing boards, the Sarbanes-Oxley Act of 2002. Congress passed that legislation in response to the financial scandals at Enron and MCI WorldCom—crises that had destroyed investor confidence in financial statement reporting.

Moreover, this role was also drafted into the general corporation law of the State of Delaware, the jurisdiction where most American companies have been incorporated since the 1960s. And this duty additionally appears throughout the corporate governance standards required of member firms holding seats on the New York Stock Exchange.

The problem is that these legal requirements were drafted based on theories rather than based on data about the real-world behavior of board members. In other words, because the economists and regulators never asked board members about their practices, they failed to account for how those directors typically carry out their duties in the real world.

Why Directors Favor Collaborating with CEOs

So despite what these laws and regulations require, directors almost never vote against decisions by chief executives. That’s because the directors don’t believe their voting on executive proposals amounts to an effective way to boost profits or shareholder value.

As recounted by Dr. Graffin, when the researchers specifically asked follow-up questions about monitoring chief executives in this way, the board members would typically correct the interviewer by pointing out that they disagreed with the premise of their question. Usually, the directors would then emphasize that they don’t want to monitor decisions by the CEO because they don’t believe it’s their job to do so. The board members instead talked about how they believe that they are better off partnering with the CEO and helping to craft their proposals into the best they can be.

The directors would also admit that they didn’t believe that they could effectively monitor executives, even if they wanted to do so. The reason is that such a substantial “information gap” exists between all the data available to the CEO, compared with the sparse data available to board members, that this chasm makes monitoring requirements seem not only unrealistic but far-fetched. Here’s how Dr. Boivie explained this information gap to Andrew Jennings on the Business Scholarship Podcast:

Let’s just think about this idea, that the board should monitor to stop “unsavory initiatives.” Or, if the CEO is floating a plan that’s suboptimal for the firm, they should vote it down. Let’s think about what it would take for a director to be in that position.

Think about a CEO. The reason they were hired as CEO was that the board thought that they were the most qualified person to do it. They have access to all the internal information. They live and breathe this organization’s strategy, they work with the people, they develop plans, and they bring this plan to a director.

With an independent director, that means: one, they don’t work for the focal firm, so they’re not involved in daily operations, and two, they have no business relationships with the firm.

So what you’re expecting from a director is to walk into a board room, and assess a plan presented by a CEO—probably with a lot of data—[although] the CEO is the only internal member from the organization on the board. And the board member needs to understand the plan and understand all the other various choices the CEO could have pursued but didn’t, and then they need to be able to recommend what the CEO should have done.

When you start to unpack the theory into an actual context or strategic decision, you start to think,“Is it plausible to think that a director who flies into the corporate headquarters four times a year can actually make those sorts of assessments to undertake activities that agency theory assumes they’re going to do?”

Given these implausible objectives, many directors told the researchers that they believed the corporation was instead paying them to assess the quality of the CEO. But they argued that there’s no way that they can accurately evaluate the chief executive’s performance if they’re constantly voting down all their proposals. They further argued that if they lost confidence in the CEO, they should instead fire that chief executive and hire another CEO whom they can work with and trust.

Boardroom Dynamics and Directors’ Perception of “Service”

One particularly intriguing finding of this research relates to the refined and rarefied culture of these boards. Because they tend to be former senior or chief executives, many directors framed their jobs as one of “service,” such that by accepting directorships, they feel that they are “giving back” to the corporate community.

The professors report that because directors believe they’re serving their colleagues, they are reluctant to tolerate tension or conflict in the boardroom—and this preference affects the tone of their interactions with the CEO and with other directors. In other words, if board members can’t work within a positive environment marked by mutual respect and trust, or if their interactions are marred by conflict, they say they won’t continue working as a director for that particular company. And adversarial clashes with CEOs don’t fit with the cooperative, genteel interactions upon which those directors insist.

This finding also puts an interesting spin on the directors’ perceptions of “service” and “giving back”—figures of speech that in related charity contexts frequently refer to some form of nonprofit or volunteer work. But these directorships are anything but poorly compensated.

According to Indeed, in 2023, the average annual compensation for a board member at a private United States company was $89,919, not including benefits like transportation, meals, and lodging. For a director at an S&P 500 company in 2018, their average salary climbed to $305,000. Moreover, according to Veritas—an executive compensation consulting firm—peak compensation at blue chip companies like Goldman Sachs might reach as high as half a million dollars. But on average, a board member would be responsible for attending only eight meetings per year.

What Do These Findings Imply?

Any time a corporation’s actions or inactions negatively affect stakeholders—such as when that firm initiates massive layoffs like Twitter, Google, Amazon, and Facebook did in early 2023, or goes bankrupt after apparently defrauding investors in the case of FTX—elected officials, regulators, and the press start looking for scapegoats to blame.

But based on the results of this study, society appears to be caught in a dilemma if it wants boards to hold chief executives accountable.

One future option might be to encourage CEOs to select very different types of directors for their corporate boards. If it were somehow possible to incentivize CEOs to nominate board members who actually believe that enhancing profits or shareholder value might be achievable through monitoring chief executives, it might eventually be possible to bring boards into compliance with statutes like Sarbanes-Oxley.

However, such an approach might never begin to produce results for another five or ten years, and it might be challenging to find and hire board members willing to actually comply with monitoring objectives.

A second option exists, and this one is available right away. Here’s how Dr. Boivie summed things up:

Our study shows investors and regulators need to reconcile their expectations of directors with the realities of the boardroom. A board’s ability to monitor for fraud, corruption, or other problems is limited at best, especially given the information gap between managers and boards. And since directors say they see their role as helping CEOs increase profits, it seems unlikely to expect them to clash with executives over how they go about it.

On balance, because expecting board members to hold CEOs accountable isn’t realistic in view of this research, we all may need to reconcile our expectations, so they better align with the realities of directors who define their roles as strategic advisors to CEOs.