GMI Blog – Study Confirms the Buffet Rule on Boards: Collegiality Trumps Independence

The following entry appeared as part of Governance Metrics International’s GMI Blog. GMI is the leading independent provider of global corporate governance and ESG ratings and research. Corporate stakeholders – including leading investors, insurers, auditors, regulators and others – use GovernanceMetrics services to identify and monitor risks related to non-financial measures covering key environmental, social, governance and accounting risk factors.

In prior blogs, my research premise and finds were described. Essentially, my research shows that high and low governance-rated boards demonstrate a particular behavioral pattern in the board room. There are distinct realms of the boardroom (front and back stage), each with their own unique social norms. Directors falter when they don’t (or can’t) distinguish these norms and react appropriately in each realm. In addition to understanding the distinct realms of the boardroom, my other notable finding was that there are two types of conflict present – cognitive and affective conflict. Cognitive conflict is required to generate innovative ideas whereas affective conflict deters any constructive participation. The question is why isn’t affective conflict addressed in low governance-rated boardrooms.

Perhaps the most surprising discovery of the research was why affective conflict is or is not addressed. My interviews showed a consistent theme – there is a relationship between board governance quality and prior personal relationships of board directors. High governance boards cast a wide net when recruiting directors, and often recruit people with whom the other directors did not have a prior relationship. My study showed that close to 70% of high governance-rated board directors were “strangers” when they joined their board, while only 25% of directors recruited to low governance-rated boards were unknown quantities. The obvious conclusion is that when a director has a prior relationship with a newly-recruited director – one that spans beyond the boardroom – directors are driven by their desire to maintain a congenial relationship with one another. There is a personal incentive to not “rock the boat” of their outside relationship by addressing affective conflict in the boardroom, even at the expense of the quality of board dynamic inside the boardroom. This reminded me of Warren Buffets admission in his 2002 annual report: “[directors], decent and intelligent though they were, simply did not know enough about business and/or care enough about shareholders to question foolish acquisitions or egregious compensation. My own behavior, I must ruefully add, frequently fell short as well: Too often I was silent when management made proposals that I judged to be counter to the interests of shareholders. In those cases, collegiality trumped independence.”

Conversely, in high governance-rated boards, where directors only have the boardroom as the context of their relationship, it becomes even more important to address affective conflict to make sure that the work environment be productive. Therefore, on the low governance-rated board, characterized by prior relationships, directors are loathe to point out and address affective conflict for fear that the confrontation will have a far-reaching impact in all spheres of their relationship. On high governance-rated boards, directors are not willing to “sweep issues under the carpet” for the sake of keeping “peace” when the health of the company is at stake. My research showed that high governance-rated boards more actively addressed affective conflict and eliminated it from the boardroom so that the impediments to a robust dialogue don’t exist and creative and innovative thinking can be fostered.

The moral of the story – recruit the best people you can to the boardroom – cast a wide net, get the most experienced, most connected people and screen director candidate for their behavioral characteristics. Beware of recruiting your pal to the boardroom because even if you think you’re doing yourself and your qualified friend a favor, the outcome may be detrimental to your relationship, corporate governance quality and ultimately shareholder value creation.

June 10, 2013 in Corporate Governance, Daily Viewpoint

By Solange Charas, Guest Blogger

PhDc, Case Western Reserve University
President, Charas Consulting, Inc.

The Board Director Training Institute (BDTI) is a "public interest" nonprofit in Japan dedicated to training about directorship, corporate governance, and related management techniques. It is certified by the Japanese government to conduct these activities as a regulated nonprofit. Read a summary about BDTI here, and see a menu of its services for both corporations and investors here.

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