The best of decisions come into fruition not through effortless agreements but rather through deliberations and negotiations. This is precisely wherein the efficacy of an ambivalent board comes into play, in order to keep the acquisitions and decisions of a CEO monitored.
A research paper by UCLA Anderson’s Beatrice Michaeli and Charles University’s Martin Gregor explores crucial opportunities, especially when it comes to exponential investments wherein the efficacy of an ambivalent board comes into play. An unagreeable board will ensure proper decision-making only after conducting a well-rounded evaluation of a particular project or venture.
The efficacy of an ambivalent board also assumes particular importance in halting projects that might pose uncertainty of some kind taking into account the negative impact that a particular imprudent decision might inflict on the reputation of the board members. Therefore, while it is essential for the CEO and the board to function together in order to put forward the best interests of the organization, exercising caution, deliberation, and ensuring accountability, is equally important, likewise, to effectuate the most beneficial of decisions.
During its long rise, through the tenure of CEO Jack Welch and then well into the reign of his unfortunate successor, Jeff Immelt, GE’s board signed off on many deals that ultimately wiped out shareholder value. A working paper suggests the company might have been better off with directors who were more hostile to management’s acquisition spree.
The paper, from Charles University’s Martin Gregor and UCLA Anderson’s Beatrice Michaeli, employs a theoretical model to suggest that, when faced with an “empire-building” CEO, an unfriendly board would be less likely to approve projects that damage the value of the company. Such boards would be less willing to rubber-stamp deals suggested by the CEO and more likely to demand the executive provide more complete data about an investment’s value.
How Board Alignment Affects Investment Efficiency
As a result, the company might make fewer bad investments and more profitable ones. This theoretical prediction is consistent with empirical findings that when shareholder activism leads to hostile boards, companies make fewer investments and are more profitable.
“Reducing the alignment of interests between CEOs and boards can improve investment efficiency,” the authors write.
The authors’ model considers a board that can be biased. Broadly speaking, based on its bias, the board can be classified into one of three categories:
Biased toward approving the CEO’s projects because directors are company insiders or are otherwise loyal to the chief executive.
Biased against approval, perhaps because directors are concerned that a bad decision will have negative environmental impact or might damage their reputation. Such a board will reject many of the projects brought by the CEO unless they have sufficiently high value.
Neutral. This board will sign off on only those investments that the CEO shows will deliver shareholder value.
Some investments that are brought for board approval are routine —such as improving an existing product line or acquiring a company in the same industry. For these projects, the board follows a set procedure in assessing their value and has all the necessary information.
Others projects are considered novel — such as an acquisition in a new industry or development of a new product — and their value is less obvious. Here, the board has to rely on information about the value of the deal that’s gathered and presented by the CEO.
In the model, an empire-building CEO — one who favors acquisitions and investments —seeks to win the board’s approval for his deals. The CEO, knowing the preferences of the board, designs how the information about the value of the investment is reported to the board. The purpose is to convince directors that the project is worthwhile.
