Representation, Materiality and Decision Control - Essays on the Role of Board of Directors as an Intermediate Actor in Corporate Governance

Abstract

Board of directors has an independent and intermediate role in corporate governance. The role of board consists of two related but separate relationships, one towards shareholders and the other towards management. Shareholders delegate the majority of their powers to directors, and directors independently determine which decision rights they hold and which they further delegate to management. Boards have the challenging task of channeling a diverse collection of shareholder preferences into an organized decision-making structure that is capable of action. This dissertation consists of four essays that investigate the distinct role of the board. The general framework for all essays arises from a Principal-representative-delegate model of governance, which can be seen as a refinement of classical agency theory. In this model, shareholders are seen as principals, board as representatives of shareholders and management as delegates or agents of directors. Board determined decision rights are used as a lens throughout the dissertation to explore board relationships, first essay building the basis for subsequent empirical analysis by investigating the concept of materiality from ex ante decision-making perspective, rather than the ex post approach of audit and legal research. Second essay focuses on representation and accountability which define the relationship between board and shareholders, arguing that in closely held companies boards act as delegates, showing face-to-face accountability towards largest shareholders, while in widely held companies they act as trustees, using independent judgment and establishing their accountability through more extensive disclosure. The third essay analyzes the determinants of division of power between directors and management finding that board decision control is independent on ownership structures, directors effectively mitigating horizontal agency problems. However, duality of CEO/Chairman roles reduces board powers, suggesting that traces of vertical problem still remain. The final essay investigates what happens to the role of the board in situations of financial distress, where creditor interests surpass those of shareholders, discussing the role of directors in controlling the potential moral hazard when most of the financial risk falls on creditors. The dissertation is the first study systematically investigating matters reserved to the board through collecting and analyzing board rules and decision thresholds as determined by directors in 600 largest European companies by market capitalization. This hand-picked material provides novel data for understanding board's role as the epicenter of corporate decision-making, and opens up new avenues for understanding what boards actually do by analyzing their influence on decision control. Allocation of decision rights is crucial for governance process. If they are set too low, boards become de-facto managements, while if they are set too high, boards fail to represent shareholder interests properly.