Agency theory

History of agency theory

Boards of commercial corporations were developed as a result of the industrial revolution, the
growing commercial complexity of business and the gradual separation of ownership, and risk,
from control. Trading, banking, transport and utility companies led the way before
manufacturing in assuming corporate form. The significance of this silent revolution is
eloquently outlined by Berle and Means22 in the preface to their classic text:

It is of the essence of revolutions of the more silent sort that they are unrecognized until they are
far advanced. This was the case with the so-called ‘industrial revolution’ and is the case with the
corporate revolution through which we are at present passing.

The translation of perhaps two-thirds of the industrial wealth of the country [USA] from
individual ownership to ownership by the large, publicly financed corporations vitally changes
the lives of property owners, the lives of workers, and the methods of property tenure. The
divorce of ownership from control consequent on that process almost necessarily involves a new
form of economic organization of society.. . .

When these subjects are thought through there will still remain the problem of the relation which
the corporation will ultimately bear the state – whether it will dominate the state or be regulated
by the state or whether the two will coexist with relatively little connection. In other words, as
between a political organization of society and an economic organization of society which will
be the dominant form? This is a question which must remain unanswered for a long time to
come.

(pp. lii–liv)

The influence on society of how business is conducted is undisputable: ‘With 50 of the world's
largest economies being companies, and the 500 largest corporations controlling 25% of the
world's economic output, the impact of business on society is undeniable’ (p. 96).30

The earliest fully developed theory about boards was thus agency theory, at the heart of which
lies questions about the organisation and ownership of property and the distribution of power that
goes along with that. Over the past few centuries, the holding of property has moved from being
an active to being a passive affair. Evolution of control has been classified by Berle and Means 22
as (1) control through ownership, (2) majority control, (3) control through legal device, (4)
minority control and (5) management control (p. 67). When ownership is held by a very large
number of individuals and bodies with none holding a significant proportion, control is
effectively handed over from owners to managers. A total of 44% of the largest 200 US
corporations in Berle and Means's study22 were found to be under management control in 1929
(p. 106), rising to 84% by 1963. Agency theory is predicated on the notion that the shareholders'
and managers' interests are likely to be different and that the behaviours of both sets of actors are
characterised by self-interested opportunism.22 Those in control ‘can serve their own profits
better by profiting at the expense of the company than by making profits for it’ (p. 114).22
There is a prehistory here that it is worth examining. Germane to the public sector focus of this
study, before the industrial revolution, charities and municipal authorities were the earliest
examples of corporations. In 1614, Sir Edward Coke confirmed both the legal personality and the
abstract nature of corporations and remarked in the case of a contested estate in relation to which
funds were vested in Sutton's Hospital:

the Corporation itself is only in abstracto, for a Corporation aggregate of many is invisible,
immortal, & resteth only in intendment and consideration of the Law; and therefore it cannot
have predecessor nor successor. They may not commit treason, nor be outlawed, nor
excommunicate, for they have no souls, neither can they appear in person, but by Attorney. A
Corporation aggregate of many cannot do fealty, for an invisible body cannot be in person, nor
can swear, it is not subject to imbecilities, or death of the natural body, and divers other cases.

Coke 1614, cited in Coke and Shepherd43

Although boards were supposed to represent the interests of absent owners or shareholders (the
principals), and management became the agents of the board, Adam Smith44 highlighted what he
saw as the hazards of diverting the control of company resources away from the owners:

The directors of such companies . . . being the managers rather of other people's money than of
their own, it cannot well be expected, that they should watch over it with the same anxious
vigilance with which the partners in a private copartnery frequently watch over their own.

p. 439

Analysis of agency theory

Coming now to the present day, agency theory, with its emphasis on conformance, suggests that
the monitoring role of the board, supported by processes such as external audit and reporting
requirements, is likely to reduce problems of management pursuing their own interests or
performing poorly (Box 3 provides a summary of the implications of agency theory for an
understanding of board governance). The emphasis is on avoiding performance problems
stemming from poor management or inappropriate use of managerial discretion. The theory is
underpinned by a belief derived from neoclassical economics that, as both principal and agent
are utility maximisers, the latter is not likely to always act in the interest of the former. Agency
costs are incurred in acting to minimise the gap between the two sets of interests. Jensen and
Meckling45 elaborate on the three sources of agency costs: monitoring expenditure, bonding
costs (to tie the agent in) and residual loss (the costs of agents' decisions which diverge from
those that are in the best interests of principals). These authors also emphasise the generality of
the agency problem, both at all levels of management and also across different types of
organisations, including non-profit organisations (NPOs), government corporations and co-
operatives. This is derived from a view that most organisations (private firms, NPOs,
government bodies) serve as a nexus for a set of contracting relationships among individuals.45
BOX 3

Implications of agency theory for an understanding of board governance Boards have a

responsibility to mitigate the risks inherent in the separation of ownership from management

Fama and Jensen46 further explicate the value of agency theory by explaining the circumstances
in which a separation of decision management (generation and implementation of proposals) and
decision control (ratification and monitoring processes) is indicated. This includes large
corporations, and also most NPOs and government bodies when there is a degree of complexity
or size which means that there is a hierarchy and a diffusion of decision management and when
important decision-makers are not exposed to significant risk by the financial effects of their
decisions, which is indeed a distinctive characteristic of NPOs and government bodies.

Eisenhardt47 urges the use of agency theory to investigate problems that have a principal–agent
structure, for example information asymmetry, outcome uncertainty and risk, offering an
empirically testable perspective on the challenges of co-operative effort. Rather than wholesale
adoption or rejection, this author advocates its deployment when there are particular contracting
problems, goal conflict or lack of clarity, and in tandem with other organisation theories.

Agency theory carries with it certain assumptions about human behaviour and, for public sector
bodies, certain assumptions that governments make about human behaviour. For health care, the
assumption behind agency theory is about the need to rein in the self-serving behaviour of
managers and clinicians, as well as the need to mitigate against poorly performing managers,
which has also been termed ‘honest incompetence’.48

Recent critiques of agency theory claim that it downplays the complexity of individual
motivations and permutations of organisational life and that it relates to a view about the self-
centredness of human behaviour in organisations which is now contested.26,49 Huse et al.50
challenge a core assumption behind agency theory, which is the possibility of complete
contracting ex ante for all stakeholders. Without this, and with the probability of incomplete
contracting, other theories emerge naturally. In a meta-analysis, Deutsch51 found little support
for agency theory's prediction about the impact of board composition, particularly the proportion
of outside directors, on critical decisions, for example around CEO compensation, risk and
control, that involve a potential conflict of interest between managers and shareholders. Relating
closely as it does to the monitoring and compliance aspect of the board role, which is commonly
regarded as a cornerstone of board work, agency theory nevertheless continues to hold sway and
dominates the literature about board theories (see Figure 2 for a timeline: out of 174 articles
accessed relating to different board theories over the past 17 years, 105 discussed agency theory,
although the backlash against agency theory was most notable around 2004–6).
One possible reason for the continued primacy of agency theory is the development of a
modernising behavioural variant. This argues that in some circumstances boards may opt for
behaviour-based rather than outcome-based incentive schemes for its executives to achieve
alignment and optimal contracting.47,52,53 Behavioural agency theory proposes that the traditional
advocacy of incentives based on firm-level outcomes may, particularly in view of the
impossibility of complete ex-ante contracting, lead to unintended consequences.53 Behavioural
agency theory proposes that incentive alignment can be achieved through outcome-based
contracts, behaviour-based contracts or a combination of the two.47,52,53 Whereas outcome-based
contracts link CEO pay to firm-level performance, behaviour-based contracts link pay to the
board's direct supervision of CEO behaviour, decisions and actions, which, in turn, are assumed
to have a positive, if indirect, influence on firm performance.53 Capezio et al.42 argue the case for
behavioural agency theory to mitigate against the potential weaknesses of outsider directors who
may suffer from information asymmetry and who may be excessively influenced by institutional
emulation or social identity issues in their approach to the setting and controlling of organisation
targets, performance and executive incentives.

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Stewardship theory
Stewardship theory was developed as a challenge to beliefs that managers are always self-
interested rational maximisers, first by Donaldson54 with later development by Davis et al.26 and
Cornforth31 (Box 4 provides a summary of the implications of stewardship theory for an
understanding of board governance). According to stewardship theory, the goals of board
directors and of their managers are aligned, with the latter being intrinsically motivated to act in
the best interests of the organisation and to focus on intangible rewards such as opportunities for
personal growth and achievement. The theory relates to a very different human relations
perspective from the one that underpins agency theory, one in which, in general, people are
motivated to do good and to act unselfishly, as long as a number of organisational and cultural
preconditions are satisfied.26 In this model, managers and owners share a common agenda and
work ‘side by side’; the emphasis is on the board's role in developing strategy rather than on
monitoring performance and a preponderance of internal (or executive) directors with high levels
of access to information is favoured.31 Implicit in stewardship theory is the understanding that
the owners (principals) are prepared to take risks on how managers will run their business and
provide a return on their investment, indicating a level of trust that is absent in agency theory.

BOX 4

Implications of stewardship theory for an understanding of board governance Managers on the

whole direct their efforts to the well-being of the organisation that they are serving
The theory was explicated in a large empirical study covering 658 corporate directors in four
countries. Anderson et al.55 found that boards of directors were evolving into an active
partnership with management, positioning themselves as a strategic asset to the organisation.
This partnership role is more in keeping with a model of stewardship rather than an agency
model of the board as monitor. Importantly, this co-operative role requires that the board develop
closer ties with management. The board's shift to sit closer to management might otherwise have
created an oversight vacuum but for the move toward activism by institutional investors. In the
view of the authors, this evolution of the board to strategic partner of management, combined
with increased investor monitoring, offers the potential to produce a more effective governance
regime.

Davis et al.,26 although proponents of stewardship theory, argue that, given the mixed empirical
evidence, neither agency theory nor stewardship theory represents a ‘golden bullet’ for corporate
governance. Other critiques of stewardship theory also indicate that there is, at best, mixed
evidence to support this theory56 and that its application can lay organisations open to risks of
governance failure, strategic drift or inertia. In addition, there is a danger of ‘groupthink’57 or
‘upper echelons’-dominated thinking,58 in which there is not enough independent challenge on
the board. A study of 768 US company directors showed that non-executive directors
experienced acute role conflict in having to serve the interests of shareholders while at the same
time maintaining camaraderie on the board.59 The same directors reported that non-executive
directors who were members of a remuneration committee felt compelled to appease the CEO.

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Resource dependency theory

Resource dependency theory derives from economics and sociology disciplines concerned with
the distribution of power in the firm and was developed particularly by Zahra and Pearce60 and
Pfeffer and Salancik24 (Box 5 provides a summary of the implications of resource dependency
theory for an understanding of board governance). According to resource-based theory, the
organisation is an amalgam of tangible and intangible assets and capabilities.61 Strategic
resources in particular are those that are valuable, rare, inimitable and non-substitutable.62 In this
context, the board can be seen as a strategic resource. Given that all organisations depend on
others to survive and thrive, resource dependency theory24 suggests that managing external
relationships to leverage influence and resources is the prime purpose of the board, and hence
board members are selected for their background, contacts and skills in ‘boundary-spanning’.63
Mintzberg64 called the board the mediator between internal and external coalitions, facing in to
management and out to shareholders. The use of the board as a co-optative mechanism (also
known as co-optation theory) reflects the potential of the board in fostering long-term
relationships with key external constituencies, thereby co-opting important elements of the
organisation's external environment. This is also evidenced by multiple board membership
known as board interlocks.65 The theory focuses on how uncertainty caused by external
environmental factors and dependence on outside organisations can be minimised. Four benefits
that board directors can bring include advice, access to information, preferential access to
resources and legitimacy.24
BOX 5

Implications of resource dependency theory for an understanding of board governance

Organisations depend on others for survival

Allied to resource dependency, and drawing from Marxist sociology, is class hegemony theory,
according to which the members of boards and governing bodies, even in a culturally diverse
society, seek to perpetuate a ruling elite. Here, a small group of people head or direct all of the
large companies and organisations through the exercise of political, social and economic power66
and imposition of a ruling-class world view.67,68 The justification of the approach is that the
world view taken is beneficial to all and not just to the ruling class. In relation to board
governance, this amounts to an inner circle who constitute a distinct recursive semi-autonomous
powerful network deeply embedded in community and society.30

A recent review of resource dependency theory37 confirmed theoretical support and the existence
of empirical evidence for this lens for understanding boards and emphasised its contingent and
dynamic nature and its particular utility early in the life cycle of organisations and in times of
stress or decline. The theory can be criticised for an overfocus on an external locus of control
construct.69 It underplays views of the board role in determining its own future through
strategising, and in exercising oversight of internal management actions and performance.

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Stakeholder theory
Stakeholder theory comes from nineteenth-century developments of alternative forms of
organisation and control in the shape of mutuals and co-operatives (for a review with specific
interest for the health-care sector see Gregory70). Recent thinking on stakeholder theory has been
developed in particular by Blair71 and Clarke36 (Box 6 provides a summary of the implications of
stakeholder theory for an understanding of board governance). There is a view that an exclusive
focus on shareholder interests has not held the key to good corporate performance and effective
accountability. In an age of vocal consumer groups, employee activism, media monitoring and
now social networking, the assumption that only shareholders are capable of effective
monitoring looks increasingly flawed.36

BOX 6
Implications of stakeholder theory for an understanding of board governance The role of the
board is to ensure the longer-term survival and value creation for the organisation and is
dependent on the commitment of key stakeholders not just shareholders (more...)

According to stakeholder theory,72 board members work to understand and represent the
different interests of individuals and groups who have a ‘stake’ in the organisation. Stakeholders
are all those whose participation is critical to the survival of the organisation.73 These include
managers, employees, customers, suppliers (contractual stakeholders) and the community, that
is, consumers, regulators, government, pressure groups, media and local communities.73 The
argument runs that the inclusion of a range of different stakeholders drives an inclusive approach
that represents a wide spectrum of societal opinions, balances competing priorities and avoids
dominance by one group with particular interests. Among the myriad of stakeholders,
stakeholder theory also argues that boards have to identify the critical stakeholders (e.g. key staff
groups) whose commitment is essential for long-term value creation. According to stakeholder
agency theory, managers are seen as the agents for all of the stakeholders, not just the owners.74

The genesis of stakeholder theory can be traced back to the co-operative movements of the
nineteenth century. Although Berle and Means' classic text22 is cited as the leading proponent of
agency theory, their conclusions actually herald the notion of corporate social responsibility, and
the importance of a community theory for how corporations should be managed, and they begin
to address the broader question of what corporations (and therefore boards that manage them) are
for:

This third alternative offers a wholly new concept of corporate activity. Neither the claims of
ownership nor those of control can stand against the paramount interests of the community. . .it
seems almost essential if the corporate system is to survive. . .that the ‘control’ of the great
corporations should develop into a purely neutral technocracy, balancing a variety of claims by
various groups in the community and assigning to each a portion of the income stream on the
basis of public policy rather than private cupidity.

pp. 312–13

Penrose75 developed the intellectual foundation of stakeholder theory in her proposition that the
company can be seen as a bundle of human assets and relationships. Blair71 argues that, if
organisations are viewed as institutional arrangements for managing relationships between all of
the parties that contribute to the wealth of the enterprise, not just the shareholders, management
has to take into account the effect of corporate decisions on all stakeholders. Thus, the control
rights should be allocated according to all of the stakeholders who provide the sources of firm
value creation and who bear risk. In some interpretations of stakeholder theory,71 a hierarchical
distinction is made between ‘taking into account’ the views of stakeholders and ‘being
responsible to’ the shareholders.

Blair further argues that there developed an accommodation of the classic property conception of
the corporation with a newer social entity conception, backed by developments in US law that
protected companies which engaged in socially responsible behaviour that might not directly, in
the short term, maximise profits for shareholders but that benefited shareholders in the long run,
on the premise that the well-being of communities in which companies operate was considered
good for business.

In practice, given that knowledge is these days the pre-eminent resource and that knowledge is
generated by individuals, elements of the stakeholder approach are increasingly utilised. Only by
creating great relationships with employees, customers, suppliers, investors and the community
will organisations learn and change fast enough.36 This argument is backed by Kaufman and
Englander76 in their advocacy of the ‘team production’ model of corporate governance, which
draws from a stakeholder view for board membership to include representation from those who
add value, assume risk and possess strategic information.

Stakeholder theory has been challenged by some, for example Von Hayek,77 who argues that
allowing management to use company resources for ends other than a direct increase in
shareholder value confers on them ‘undesirable and socially dangerous powers’ (p. 100). Other
arguments against the stakeholder view include diversity of and lack of clarity about stakeholder
expectations, complexity of trade-offs if stakeholder interests are to be taken account of and the
need for a simple focus of the bottom line for managers.78

Despite the fact that stakeholder governance models are deeply embedded in some countries in
Europe, notably Germany, and in Japan, and that claims for these countries' industrial and social
success are often based on this model, the empirical evidence for stakeholder theory is weak. In a
study of 250 firms and more than 3000 directors, Hillman et al.79 found no association between
the presence of stakeholder directors on the board and organisational performance. The theory
can be criticised for encouraging risk-averse, inoffensive but bland and lowest common
denominator decision-making. It can lead to large and unwieldy boards with people recruited for
whom they represent rather than for their board-level skills.80

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Theories about the exercise of board power

Berle and Means,22 in relation to agency theory, delineate between the three main aspects of
enterprise: (1) having power with ownership and taking action, (2) the diverse situations of
owners without appreciable power and (3) having power without appreciable ownership (p. 112).
Power can be defined as the ability to influence others and, in relation to boards, Huse et al.50
argue that the literature on power can usefully be divided into four main groups. These are direct
power, indirect power, conscience-controlling power and institutional power. Power differentials
between members of the board affect both processes and outcomes (Box 7 provides a summary
of the implications of board power theory for an understanding of board governance). Mace 81
found that the gap between expectations of boards and actual practices could at least in part be
explained by power relations.
BOX 7

Implications of board power theory for an understanding of board governance The holding and
exercise of power on the board changes over time and power distance between members on the
board can also vary

Models of board behaviour and exercise of power can be related to the main theories about
boards: for example, agency theory is connected to a ‘challenge and compliance’ set of
behaviours, whereas stewardship theory relates to a high-trust partnership style of working, and
in a stakeholder model board members tend to be most vocal when articulating the interests of
‘their’ constituency.80 Power boards are those to which influential boundary spanners have been
recruited, in a model closely related to a resource dependency view of the board.30

In an amplification of their view that one size does not fit all, Davis et al.26 propose that
participative, empowered, involvement-oriented management culture with lower power distance
is more likely to produce principal–steward relationships, and that a control-oriented
management, with individualist culture and transactional leadership characteristics and high
power distance, will, conversely, produce principal–agent relationships. The authors further
indicate that both the principal and the agent (manager) are psychologically predisposed to one
or other relationship but do have a choice. They conclude that, if there is an agreed mutual
stewardship relationship, the potential performance of the firm is maximised and, if there is an
agreed mutual agency relationship, risks and costs are minimised.

In his influential piece on the exercise of power by independent directors of the board, Mace82
argues that, at least at the time of writing, there is a substantial gap between the myths of
business literature and the realities of business practice. Directors do give advice, set discipline
and provide decision-making in times of crisis but are less likely to exercise influence over
strategy or to ask discerning questions or in reality take charge of the CEO selection process.
This all suits CEOs who, according to the managerial hegemony frame, do not want the directors
too involved in the company. In a more nuanced contribution, Lorsch and MacIver83 chart the
rise and fall and rise again of the potential power vested in the independent director. This has to
do with the increase in the proportion of outside directors, and the multiple sources of power,
which include legal authority, stakeholder expectations and personal confidence as well as the
power of unity of purpose amongst board members. Kosnik84 argues for merging agency and
managerial hegemony theories to clarify the contingencies that might affect board performance
in corporate governance. The argument runs that one is not more valid than the other but that the
switching rules need to be identified.

Related to this are theories about the sources and use of board power, including the power of the
chief executive,85 the exercise of managerial hegemony,35 the discretionary effort and skill
exercised by non-executive board members86 and the increased role of the board in periods of
crisis or transition,83 which can be followed by ‘coasting’ according to the stress/inertia theory. 87
Critiques of models of board power argue that there is a sometimes mistaken assumption that
board members are able to exercise influence over senior management, and that it is through this
influence on management that they are able to bring about change and influence organisational
performance.5
Three main rules governing the proper exercise of power by management have been developed
and tested legally: a decent amount of attention to business, loyalty to the interests of the
business and reasonable business competence (p. 197).22 Managerial power theory argues that
board structures set the conditions for board control. Boards dominated by managers are seen as
weaker monitors and compromised, as the CEO can exercise inappropriate influence over his or
her own, and fellow executives', compensation and career advancement.88 Further, managerial
power theory proposes that a CEO who is also a board chairperson (chairperson–CEO duality)
has the power to influence board decisions in general and to create the conditions for board
‘capture’.89–92

Power circulation theory explains political dynamics amongst elites93 and was extended to the
corporate governance context by Ocasio,94 Shen and Cannella95 and Combs et al.96 The theory
suggests that top management in organisations is inherently political, characterised by shifting
coalitions and continual power struggles.94 Power circulation challenges the notion that CEOs
can perpetuate their power.94,97 Instead, it suggests that managerial power ebbs and flows
because of political obstacles and triumphs arising from the shifting allegiances of colleagues
and rivals. Combs et al.96 argue that a board with a majority of outside directors is only
important to control a powerful CEO and that a weaker CEO can be adequately controlled by the
other executives.

Finally, in relation to Huse et al.'s allusion to conscience-controlling power,50 corporations may

transgress because, although they have power, they lack the conscience to do good, as they have
‘no soul to be damned and no body to be kicked’ (Edward 1st Baron Thurlow, English Lord
Chancellor 1778–92, quoted in Coffee,98 p. 386). This begins to indicate the requirement for an
agency theory in reverse – the need to consider who controls or regulates the decisions and
actions of the board, and a revisiting of Berle and Means' question22 about whether the political
or the economic organisation of society should dominate (p. liv).

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Developing a realist interpretation framework of board

theories, contextual assumptions, mechanisms and intended
outcomes
The terrain is characterised by some complexity in terms of the multiple locations of the
evidence across different disciplinary traditions. Drawing together these theories is a daunting
task. Within a realist frame, the focus is on offering explanations rather than judgements, and
developing principles and guidance rather than making rules.16 In line with a realist view, it
seems to us that underpinning the main theories about the role of boards is a series of contextual
assumptions, mechanisms and intended outcomes. These are summarised in Table 7.
TABLE 7

A realist interpretation framework of board theories, contextual assumptions, mechanisms and

intended outcomes

The theories suggest that boards face choices. If the main intended outcome is for the
minimisation of risk (e.g. patient safety), it follows that the main mechanism should be
monitoring, predicated on agency theory. This may come at the expense of innovation, however,
which is predicated on stewardship theory, with a mechanism of collaborative working on the
board. When there is an issue around power (e.g. in health care, the power of the professions, or
the power of the regulator), the mechanism of power differentials may need to be deployed to
ensure equilibrium. In the context of long-term service commitment in a health-care system, a
multi-stakeholder approach involving collective effort may be indicated, with an outcome of
long-term added value.

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Board practices
What do boards actually do, what should they do and how does this relate to theories about
boards? There have been calls for frameworks that combine the insights of different theories.31,99
One useful model has been proposed by Garratt,33 drawing on an earlier model by Tricker.99
Garratt suggests that there are two main dimensions of the board's role, what he calls
‘conformance’ and ‘performance’. Conformance involves two main functions: external
accountability, including compliance with legal and regulatory requirements and accountability
to shareholders or other stakeholders, and supervision of management through oversight,
monitoring performance and making sure that there are adequate internal controls. This
conformance dimension matches quite closely with the agency theory perspective on
governance. In contrast, the performance dimension is about driving the organisation forward to
better achieve its mission and goals. This again consists of two main functions, policy
formulation and strategic thinking, to take the organisation forward. The performance dimension
is in keeping with stewardship theory of corporate governance. This framework (depicted in
Table 8) suggests that boards need to be concerned with both the conformance and the
performance dimensions of corporate governance.
TABLE 8

The main functions of boards

Carver100 proposes a ‘policy governance’ model. He claims this to be a universally applicable

theory of governance that, with the board as servant-leader, and a strict separation of governance
from management, is a conceptually coherent paradigm of principles and concepts encompassing
ends, executive limitations, governance processes and board–ownership and board–staff
linkages. The model can be criticised for similar reasons as the weaknesses exposed in agency
theory, which it draws from: the distance between the board and the management of the
organisation can mean that essential monitoring does not take place, and it might not be fit for
purpose during turbulent times in the life cycle of the organisation.

As an alternative, and of particular relevance, but not exclusively, to the non-profit sector, Chait
et al.32 propose a hierarchy consisting of three essential components of governance: fiduciary,
strategic and generative. Fiduciary duties, or the monitoring and compliance aspects, relate to the
legal responsibilities of trustees and to the agency theory of governance. The strategic
component relates to the work of the board in setting direction and is closer to the ‘performance’
aspect of Garratt's33 two main dimensions of board work. Generative governance is also about
performance but it encapsulates leadership through governance and thereby aims for
organisational renewal as well as tasks relating to strategy. Boards exercising generative
governance can help organisations to unlearn organisational practices that have become
unhelpful101 by diagnosing new opportunities, new performance measures and new control
systems.

Garratt's33 and Chait et al.'s32 approaches emphasise mainly the importance of task and process,
with a relative neglect of questions of composition and dynamics. Stiles and Taylor30 start with
the premise that there are three main roles for boards (strategic, control and institutional) but then
focus in their empirical study on the ‘board at work’, examining the contexts and processes that
influence, constrain and enable the degree to which they are able to carry out their functions.
Recent literature increasingly distinguishes between board structures and processes.102 There is
an argument that the key to unlocking the ‘black box’ of board theories and effective board
practices may lie in pursuing insights into three key elements – the composition of boards, the
focus of board effort and board dynamics – and that these insights may point to the emergence of
a refined composite theory for boards.

Composition of boards
Senior executives of the enterprise comprised a majority on boards at the time of writing of Berle
and Means22 in the early 1930s, and it was these that were the focus of the authors' concerns
about the distancing of management from ownership control. Since that time there has been a
rise in the proportion of outside or non-executive directors on boards representing the interests of
shareholders and owners. In addition, there has been the evolution of different board structures –
in particular the unitary US/Anglo Saxon model in which managers and outside directors sit
together on a board, in contrast to the two-tier Rhineland model, typified by the German
Vorstand (management board) and Aufsichtsrat (supervisory board). To address the perceived
problems outlined in agency theory, there has also been a move to split the roles of chairperson
and chief executive, in contrast to a single person holding both positions (CEO–chairperson
duality). Stiles and Taylor30 argue that even the unitary board is ‘internally differentiated’ (p.
106), acknowledging that the chairperson, executive director and non-executive director
represent different constituencies.

The quest for the ideal board form seems, from the evidence so far, to be a chimera. In a meta-
analytic review of board composition, leadership structure and financial performance, Dalton et
al.27 found no links between these, and nor did an analysis a decade later focusing on CEO–
chairperson dualities and insider/outsider composition.103 There is some weak evidence (e.g.
from Ireland104) that boards of a smaller size are related to stronger organisational performance
(although this is less significant in smaller firms) and some evidence that a majority of
independent/outside/non-executive directors is also associated with better performance.104

During crises, there is some evidence from the work of Perry and Shivdasani105 that boards with
a majority of outside (non-executive) directors are more likely to initiate restructuring and lay-
offs and secure subsequent improvements in operational performance. The authors conclude that
board composition in these circumstances has a material impact on board performance. Although
the relative numbers of outside directors is of interest, this may also endorse the different role of
boards in times of crisis.83

Board diversity (specifically the presence of women – other under-represented groups have
received less attention106) has been examined over a number of years. Some authors have found
positive107 and others negative108 effects on ability to achieve strategic change and on firm
performance; one meta-analysis has concluded that there is no effect on organisational
performance – at least in the USA.109 There are some straws in the wind, however, that greater
social diversity in the boardroom may enhance board strategic efficacy and, hence, firm
performance.110 A study of 1500 US public companies published in 2012 found that, on average,
the companies managed by a female CEO performed better.111 A burgeoning literature indicates
growing recent interest in this field.38,106,112,113 Sealy et al.106 make the case for increasing the
number of women on boards founded on four main lines of argument: the need to tap into the
widest possible talent pool; the fact that diverse boards understand their stakeholders better; it
prevents ‘groupthink’; and the increasing (recent) evidence that women on boards are associated
with better firm performance. Others114 make the point that, to avoid token theory,115 at least
three women are required on boards to make any difference.

The Davies report116 identified that women made up only 12.5% of UK FTSE 100 boards by the
year 2010, a very low rate of increase from 9.4% in 2004. It found evidence in its review that
women on boards can improve bottom-line organisational performance by modes of behaviour
that are different from those of their male counterparts, by more conscientious preparation for
meetings and by asking awkward questions more often, thereby enhancing board independence.
A recent literature review of women on corporate boards summarised the evidence about the
differences that women on boards can make. This is presented in Box 8.

BOX 8

Boards with women are more likely to . . . Identify criteria for measuring strategy

Given some (weak) evidence emerging from private and public sectors about composition, which
is discussed more fully in Chapter 5 in an exploration of links between boards and organisational
performance, non-profit boards including social enterprises may need to consider strategies to
mitigate against any potentially deleterious effects. What is emerging overall, however, is that
the ‘right’ structure and composition of boards is highly context specific: it isn't that it doesn't
matter, but what works effectively in certain circumstances will not in others and there is a
degree of specificity that is missing from current research.

Board focus

Board focus appears to be important. The emerging evidence is that high-performing boards
across all sectors concentrate on shaping strategy, resource identification and use, and talent
management.33,117,118 Lorsch and Maclver83 identified four key areas for boards: defining the
long term, and taking the lead in finance discussions, strategy discussions and developing talent.
All of these authors also stress the importance of matching the weight attached to different board
tasks with the prevailing internal situation and external environmental conditions.

Useem's117 research on good practice in the boardroom identified a series of iterative actions that
are associated with boards of high-performing organisations. This echoes Garratt's33 work on
board functions and the cycle of board tasks. Clarity about matters that should be reserved for the
board is important and these include areas that are symbolically as well as strategically
important. The reserved powers of the board in relation to strategy and performance monitoring
act as a discipline effect, particularly when the board is known as being proactive and commands
respect.30 Useem sums up by arguing that improved decision-making in the boardroom can be
generative as well as protective. This relates to Chait et al.'s32 line of argument for reframing the
work of non-profit boards.

A number of authors cite the importance of strategic planning as the sine qua non of board
work.119,120 Lorsch and Clark121 also counsel for more of a focus on the long term and leadership
from the board. They argue that there is currently a danger of too much board time spent in the
area of compliance, and that the board is too hands-off in the area of strategy, which risks the
destruction of shareholder value in the longer term as the organisation, potentially unnoticed,
goes into decline. Useem117 urges a relatively hands-on approach to strategy formulation and
execution, including breaking down large strategic decisions into smaller sequential ones for
board-level consideration.

In Stiles and Taylor's work30 the strategic role of the board is specifically identified by
respondents as the primary role of the board. The authors further pinpoint that the board role is
not to formulate strategy but to set the context, answering the question, ‘What business are we
in?’, and to act as gatekeeper in relation to strategic choices, reviewing and assessing proposals.
This view of the strategic role of the board draws from a number of the main board theories, for
example the board, with strong latent power, is acting as a strategic arbiter in accordance with
the agency view, and is executing a boundary-spanning role in relation to determining strategic
fit with the external environment.

There is some evidence30 that financial control is more formalised than strategic control. This is
aided by the universal existence of the audit committee, which scrutinises drafts of financial and
control statements and can refer documents back for clarification and amendment. Control
systems, including external benchmarking as supervised by the audit committee, can also act as
tools for diagnosis but require committee effort to pick out trends, threats and opportunities.30
The social ties that are built in the course of committee work increase a sense of common
purpose and support a stewardship theory of corporate governance. The threat is that they can
reduce vigilance and therefore the effectiveness of the board as a mechanism of control.30

In support of the pervasiveness of managerial hegemony, Stiles and Taylor30 found that control
of the CEO was often relatively weak. CEOs had very strong beliefs in their abilities. The
chairperson role in exercising control in these circumstances (as per agency theory) was very
important. But the board can be important in weeding out, most likely through informal
mechanisms, the underperforming directors.30

Board dynamics

Although most research has examined board composition and functions, there have been
increasing calls for a focus on behavioural perspectives. Finkelstein and Mooney122 argue the
need for going beyond the use of the four ‘usual suspects’ (proportion of outside directors, size
of boards, CEO–chairperson duality and share ownership by directors), which currently drive
most of the research about boards of directors. Figure 3 indicates the principal characteristics of
research on boards from 1990 to 2002 and demonstrates the relative dearth of work on the
behavioural dimension.

FIGURE 3
Characteristics of research on boards 1990–2002. Based on Gabrielsson and Huse. Reproduced
with permission from M. E. Sharpe, Inc.

Maharaj102 identifies the key components of board process as comprising the depth and breadth
of director knowledge, the motivation and engagement of directors and transmission channels for
information exchange between the board and the rest of the organisation. This is, arguably, more
about dynamics, which is the realisation or enactment of process, than about the process per se.

Huse23 in particular has argued for opening up the ‘black box’ of board working, a term used
often by authors9,124–126 indicating the difficulties and challenges of understanding the inner
working of boards. He offers a useful contextual framework (Figure 4) that can also be seen as a
depiction of the ‘black box’ of boards. On the outside of the box are the internal and external
actors, board members themselves and formal and informal structures. Inside the box are
organisation behavioural concepts such as trust, emotions, politics and expectations as well as
(the process of) internal and external value creation.

FIGURE 4

Accountability and creating accountability: a framework for exploring behavioural perspectives

of corporate governance. Reproduced with permission from Huse M. Accountability and creating
accountability: a framework for exploring behavioural perspectives (more...)

Finkelstein and Mooney122 argue that board effectiveness depends on the quality of the
individuals who become directors and their ability as a group to get the work done and, therefore,
attention has to be given to understanding how to develop group and team dynamics. Tsui et
al.127 argue that the negotiation of power sharing, not necessarily equalisation of power, between
non-executives and managers offers a way out of unhelpful board dominance by one or other
party. Pye and Pettigrew128 suggest that the study of board practices provides grist for the
development of an alternative paradigm to the agency theory of boards, which has dominated the
discourse on corporate governance. They further suggest that effective boards are more than the
sum of their parts and, although this is so far under-researched and poorly theorised, it is the
dynamic of board members working together that adds value to the organisation. This dynamic
includes non-executive directors who are ‘extraordinary’ in terms of their capacity to articulate
clearly, their capability and their conceptual awareness and whose relationships are characterised
by respect, trust and integrity.128

McNulty et al.,129 in their report for the Higgs review of the role of non-executive directors in the
UK, characterise the effective non-executive director as ‘independent but involved’, ‘challenging
but supportive’ and ‘engaged but non-executive’. These dyadic couplets also provide a means of
constructing a creative tension between agency and stewardship theories of boards and relate
also to Sundaramurthy and Lewis'130 proposal that boards should practise both control (agency)
and collaboration (stewardship) behaviours. Research carried out by Stiles and Taylor30 ranked
in descending order the qualities brought by non-executive directors as, first, objectivity
(‘outsideness’), second, advice and, third, external/expert/knowledge. This relates to agency,
stewardship and resource dependency theories and also maps on to Garratt's33 notions in his two
sets of board tasks regarding monitoring compliance and contributing to strategy. Forbes and
Milliken125 argue that effective boards combine task effectiveness with group cohesiveness but
that this is theorised as curvilinear: both positive interpersonal relations and task-oriented
disagreement are high.

In research that examined the effects of the board's working style on board task performance,
Gabrielsson and Winlund131 found that, in addition to the significance of formal board structures,
the level of board member involvement and the extent of clearly defined working styles was
important.131 This echoes the argument adduced by Pettigrew and McNulty86,132 about the extent
to which members have the ‘will and skill’ to exercise board power. Bradshaw et al.120 and Stiles
and Taylor30 note the importance of informal core groups and inner cabinets within the board that
act for change.

Brundin and Nordqvist133 found that emotions work over the long term and in the moment as
power energisers and status energisers in boardroom dynamics and that they are influential in
task performance of individual board members. Being aware of the emotions underlying board
interactions is thus crucial for being an effective board member.133

In a study of primary health-care organisations in the UK, Abbott et al.134 found that, although it
was part of their remit, board directors often avoided a challenging style in their relationships
with the executive, although the possibility that directors might challenge did affect how
business was conducted. One obstacle was relative powerlessness, particularly in the face of
overload of technical information. The authors did, however, find that the influence of directors
in subcommittees was more extensive than typically found in the private sector, with roles as
critical friends rather than as scrutineers. They conclude that these boards are better understood
as part of a network in which accountability is embedded, strategy is emergent and the
predominant mode is negotiation rather than command and control. This accords with the
stewardship and stakeholder models of boards, and complements the evidence that, in times of
turnaround, the role of the board committee comes to the fore as potentially a safer place to ask
searching pertinent questions that challenge the status quo.135 It suggests that ‘hands-on’ boards
may use their ‘will and skill’ in more subtle ways than merely through formal board meetings.

Trust is an important notion used by Roberts et al.29 Trust builds on the free flow of information
and the subjugation of personal interests30 and can be either competence based or integrity
based,136,137 the former more closely allied to agency theory and the latter to stewardship theory.
In an integration of the two, ideas such as ‘distanced closeness’ and ‘simultaneous independence
and interdependence’ were utilised in these studies by Huse.137

Four concepts in the behavioural tradition that have been applied in recent board research are
bounded rationality, ‘satisficing’ behaviour, organisational routines and bargaining among
coalitions of actors.138 Coombes et al.,139 in a study focused on the non-profit sector, argue that
boards can be characterised by underlying behavioural dimensions that go beyond issues of
composition and structure. Furthermore, they posit that a board's behavioural orientation
represents a key source of value creation. Behavioural orientation represents a fairly stable,
collective tendency of the board towards particular behaviours. Examples of behavioural
dimensions include the extent to which the board is strategic/operational,140,141
cohesive/fractionalised,142 active/passive34 or progressive/conservative.143

In relation to an evolutionary framework for boards, Stiles and Taylor30 observed a negotiated
order emerging with individual directors establishing roles, rights and obligations through
interactions over time, and the need for investment in relationship building, which in turn
supports a socialising process of accountability: ‘these interactions are unique to the firm and its
board and are difficult to imitate . . . . In terms of research on boards in general, normative
theories of board structure may be helpful only up to a point: what really matters is the intangible
asset of board cohesion.’

The role of the chairperson also comes to the fore. Kakabadse et al.144 have argued from surveys
and interviews in their study of the characteristics of world-class chairmen/women that there are
six essential and distinctive chairperson ‘disciplines’ that do make a difference on a board. These
comprise delineation of boundaries with the CEO, sense-making, interrogating the argument,
influencing the outcomes, living the values and developing the board. This lends weight to the
good corporate governance practice guideline in the UK and Europe (in contrast to the USA) of
separating the chairperson and CEO roles.

The emerging evidence concerning the behaviours of effective boards leans towards a
comparatively ‘hands-on’ board with able and relatively engaged non-executive directors. The
evidence adds up, supporting the tentative triadic proposition of board dynamics that is able to
incorporate a way of working that combines high levels of engagement within a board climate of
high trust and high challenge. This connects to a composite theoretical model of boards that
combines elements of agency, stewardship and resource dependence and thus represents a
development of the dual line proposed by Sundaramurthy and Lewis.130 This proposition also has
implications for the workings of non-profit boards aiming for generative governance,32 and calls
for the framing of a new set of relationships between the management and the board directors.

Conjunction of board role theories and board process practices

There does not appear to us to be a straightforward connection between the main theories about
the role of the board and the frameworks for board processes involving structures, focus and
behaviours, but for now we have provisionally mapped the likelihood of expected different board
practices against the main theories and this is summarised in Table 9. Along realist lines, the next
step is to interrogate the literature with regard to boards in different contexts to elucidate the
potential of this conjunction.
TABLE 9

Conjunction of main board theories and practices

Contextual and evolutionary theories

In a study critiquing the assumptions behind agency, stewardship and resource dependency
theories in links between boards of directors and organisational performance, Nicholson and
Kiel56 found that, although each theory can explain a particular case, no single theory explains
the general pattern of results. The authors suggest that the board–performance link is likely to be
highly dependent on context-specific situations such as stage of organisational life cycle, sector
regulation and competitive conditions.

Huse145 posits that the contextual factors mostly used in corporate governance research are
national, geographical and cultural differences; the industry and the industrial environment of the
corporation; ownership dispersion and types; and firm size and the actors (board members and
managers).

Using an evolutionary frame, Hermalin and Weisbach146 indicate that boards develop over time
and adopt different behaviours according to the organisation life cycle. For example, there is a
heightened role for the board in periods of crisis or transition,83 which can be followed by
‘coasting’ according to the stress/inertia theory.87 In a study examining the impact of CEO power
as a moderating factor in board composition (particularly proportion of outside directors) and
organisational performance, Combs et al.96 argue that outside director-dominated boards are best
in the early years as Shen147 suggests but are harmful in the intermediate years when the CEO is
implementing his or her ideas and necessary later when the CEO's power is growing.

Ho and Williams'148 analysis of 286 firms in South Africa, Sweden and the UK did not find a
significant link between four board features and corporate performance across the three nations.
Individual board features were found to influence corporate performance in isolated cases. The
results provided evidence that, even under different sociopolitical and economic conditions,
governance needs vary across firms. These findings lend further support to the notion that
uniform board structures should not be mandated.

Somewhat paradoxically, corporate governance convergence has been identified alongside

increasing contextual divergence.36 As a result of the rise of global markets, Europe stakeholder
capitalism is of growing interest to the traditional US/UK believers in shareholder capitalism,
and Japanese collective capitalism is now identified with superior rates of innovation and
renewal.36

Zald149 argued that board behaviour is likely to vary based on two organisational characteristics,
the first in relation to different phases of development (life-cycle stages) and the second in
relation to activity (in times of crisis and transformation and when organisation identity is
questioned), to which Miller-Millesen150 would add the degree of professionalisation. Callen et
al.151 showed for a sample of US non-profits that board mechanisms related to monitoring (in
accordance with agency theory) are more likely to be effective for stable organisations, whereas
board mechanisms related to boundary spanning (resource dependency) are more effective for
less stable organisations, confirming Miller-Millesen's150 contention that, because the non-profit
environment is often more complex and heterogeneous than the for-profit world, no one theory
describes all tasks of non-profit boards. Ostrower and Stone152 have developed a contingency-
based framework for understanding the influences on non-profit boards, which emphasises the
need to take account of and pay more attention to differences in the external environment as well
as internal differences in organisational size, complexity, maturity and degree of
professionalisation.

Conclusions

There are a number of conclusions that we can begin to draw using context–mechanism–
outcome configurations. We have seen from Table 9 on the conjunction of main board theories
and practices that board composition and practices can be mapped against particular board
theories. Furthermore, Table 8 outlines a realist interpretation framework of board theories,
contextual assumptions, mechanisms and intended outcomes. This suggests that the use of
certain mechanisms may be more appropriate than others, depending on what the priority is in
terms of organisation outcome. If the overarching aim is efficiency and minimisation of risk, an
agency approach with relatively high challenge and a higher proportion of outside directors may
be called for. If, on the other hand, innovation is prioritised, a different board structure may be
called for, with a smaller board and a greater proportion of insider directors. At the start-up stage
of the organisation life cycle, board composition may need to include boundary spanners to build
legitimacy with external partners, but the board may also need to allow some rein to inside
directors/executives to develop strategy. If outcomes for the longer term are seen as valuable, a
stakeholder model for the board may be an appropriate choice.

The research also indicates that the choice of mechanism, depending on the context, is likely to
lead to certain outcomes and may close off others. For example, a stewardship-style board will
lead to high levels of partnering, which might be to the detriment of appropriate challenge, and
unacceptably high levels of risk to the future viability of the organisation, particularly in
environmental conditions of strong competition.

In relation to board dynamics, the contingency lens signals that the ‘mechanism’ (in realist
terms) of the initial programme theory of the engaged board (high trust/high challenge/high
engagement), which was outlined in Chapter 1, is likely to have different outcomes according to
different contexts. Given what we have identified earlier, this kind of dynamic is likely to work
best in a relatively stable environment and with an organisation in a growth or a mature phase in
which the focus is on maximisation of performance rather than minimisation of risk. Some of
these dynamics may need to be modified in other conditions, for example in a start-up phase, or
when there is strong competition, an unstable environment or managerial hegemony threatens the
organisation in the longer term.

Building on this discussion of different contexts, Chapter 3 explores the distinctive

characteristics of the boards of NPOs along with health-care boards and government body boards
to begin to offer an explanatory framework for understanding what might constitute the
characteristics of effective boards in the NHS.