Therefore, nothing could actually be concluded on the affect of the national context on the actual board behaviour

BEHAVIOUR IN THE BOARDROOM

The Consequences of Board Relationships for the Roles of Board Members

HESTER KNOT 1272578

Rijksuniversiteit Groningen Msc. IB&M

Landleven 5 9747 AD Groningen Telefoon: 050 - 363 3822/3827

Fax: 050 - 363 3850 H.H.Knot@student.rug.nl

BEHAVIOUR IN THE BOARDROOM

The Consequences of Board Relationships on the Roles of Board Members

ABSTRACT

In this paper the impact of trust and power relationships on the roles of the board members is examined. Since the national context differs between countries the results of this study will be compared to the results of a similar study of McNulty et al. (2005) conducted in the UK. In this paper, the study is performed through a case study analysis of a Dutch listed company and data is obtained through interviews with the board members and observation of a supervisory board meeting. The results show that within this Dutch company trust and power relationships have no impact on the role the board members play. The comparative analysis with the study of McNulty et al. (2005) shows that the supervisors (in a two-tier system) in the Dutch company perform the same roles the non-executives (in a one-tier system) perform in the British companies. However it should be noted that the boards of the Dutch company seem to function as in a one-tier system, although they legally have a two-tier system. Therefore, nothing could actually be concluded on the affect of the national context on the actual board behaviour.

INTRODUCTION

For a well functioning economy, it is necessary to have a good system of corporate governance (Tabaksblat, 2003). Worldwide 52 countries have developed corporate governance codes in order to improve the governance of their companies¹. In the Netherlands, in 1997, the Committee Peters had made 40 recommendations for good corporate governance.

Due to several international and national accounting scandals and a strong recommendation for a national code of corporate governance for all members of the EU by the ‘High Level Group of Company Law Experts’, it was necessary to review the recommendations of the Committee Peters, which resulted in a Dutch code of corporate governance in December 2003 (Tabaksblat, 2003). The code consists of regulations with regard to better transparency of the yearly financial statement of the firm, better responsibilities of the supervisory board (Raad van Commissarissen) and a better protection of the shareholders². All firms listed at the Dutch stock exchange market should apply the code according to the rule ‘comply or explain’. This means that the firms should comply with the code or otherwise they should explain why they do not comply, in order to apply the code.

Since the introduction of the code corporate governance, most listed companies are making an attempt to introduce firm specific regulations and procedures according to the code. In principle, the code should lead to a better performance of the company, with regard to the shareholders interests. However, Van Ees and Postma (2004) argue that the code can increase the legitimacy of corporate governance institutions, especially the supervisory board, but not necessarily the effective functioning of these institutions, so that it would lead to a better performance of the company. The reason is that the code describes guidelines for the supervisory board but it says less about the actual behaviour of the supervisory board.

McNulty and Pettigrew (1999) argue that board members are able to influence processes of strategic choice, change and control. They find a significant gap between prescription that boards should be active in strategy, and empirical evidence that boards are indeed active in strategy. Also McNulty et al. (2005) argue that formal board attributes, like the code of corporate governance does not guarantee board effectiveness, it is the actual conduct of board members that determines their effectiveness.

1 http://www.ecgi.org/codes/all_codes.php. (12-09-05)

2 http://www.minfin.nl/default.asp?CMS_ITEM=563C7A0DD8074B8698078C7B4D006EDFX2X50942X76 (12-09-05)

Therefore, the central objective of this paper is to gain insight in the actual board behaviour.

McNulty and Pettigrew (1999) recognize that part-time board members (non-executives) are engaged in a dual role of monitoring and supporting the executives. With regard to this, they find three different roles board members can perform: involvement in taking strategic decisions; involvement in shaping strategic decisions; involvement in shaping the context, content and conduct of strategy. The deeper the involvement, the more the part-time board members are engaged in the supporting role. According to Westphal and Zajac (1997) trust and power relationships can influence the level of involvement and therefore the role the board members are active in. Therefore, this study will focus on the impact of trust and power relationships between board members on the different roles board members can perform. It will be carried out through a case study of a Dutch listed company.

The derived objective of this study is to analyse to what extent the behaviour within boards is affected by the national context of the companies. In this study the national context will be determined by the code corporate governance, which differs between countries, especially on the fact if the corporations of a country are viewed in a one-tier structure, (one board existing out of executives and non-executives), or a two-tier structure (in which management and supervisory functions are separated in two boards). To that purpose in this paper the results of a case study of the board behaviour of a Dutch listed company will be compared to the results of a similar analysis conducted for companies in the United Kingdom in the context of the so called Higgs review (McNulty, Roberts and Stiles, 2005).

This study will contribute to the existing literature in several ways. First, several studies have been carried out around the topics of trust relationships (Westphal, 1999; Gillespie, 2003) and power relationships (Morgan, 1997; Pettigrew & McNulty, 1998). Other studies have focussed on the different roles of board members (Huse, 1998; Forbes & Milliken, 1999;

McNulty & Pettigrew, 1999; McNulty et. al, 2005). This study will combine both elements and study the impact of one on another. Second, trust and power relationships imply that board members are not fully independent from one another. However, in the two-tier structure of the company in this case study, the supervisory board is a body that should be independent of the executive board and control this board, according to the code of corporate governance (Moerland, 1995; Huse, 1998) in order to perform the monitoring role effectively and serve the interest of the shareholders. This study will show that independency of the supervisory board is not necessary to perform the monitoring role effectively. However, during the

research described in this paper, it became clear that the two boards of the company of the case study actually seem to function like in a one-tier structure, although the company is having a two-tier structure. Since the one- or two-tier structure formed the difference in national context in this paper, the question rose if actually something could be concluded on the affect of national context on the actual behaviour of boards in this case study. The answer to this question is no. However, this research still remains valuable due to the fact that it does provide insights on the actual behaviour of board members in this company, which can be used in future research, since it is very hard to obtain the necessary data for exploring board behaviour. The comparison of the results of this study to the results of McNulty et. al, 2005, will still contribute to the literature by showing that the supervisors in the company of this case study performed the same roles as the non-executives in the research of McNulty et. al, and therefore strengthen their conclusions.

The rest of the paper is organised in six sections. The next section describes the theoretical background. In this section an overview is given of studies and theories in the field of corporate governance and board behaviour. By using this overview, the study of the impact of trust and power relationships on the roles of board members, can be positioned in a broader field of research. The section will also provide the research model for this study with propositions drawn from the literature. In the next section the research design will be described, with regard to the data collection and the data analysis. Thereafter, the background of the Dutch listed company used in this case study will be described. Information will be revealed about the history of the company, the financial performance of the company in the past view years and the composition of the board of management and the supervisory board.

Moreover, the implications of this organizational background for this study will be pointed out. The following section will contain the results of the case study analysis, thereby examining the propositions that were stated in section two of the paper. Furthermore, the comparison with the study of McNulty, et al. (2005) will be made in section six. The paper will be ended with a conclusion and recommendations for future research on the topic of behaviour within boards.

THEORETICAL BACKGROUND

According to Reid (2003) there is no universal definition of corporate governance. However, he argues that the core of the studies of corporate governance is revolving around the topics of

‘separation of ownership of control, efficient management of the firm to generate value, and the reconciliation of shareholder interests with the interests of stakeholders’ (Reid, 2003:233).

Shleifer & Visney (1997) define corporate governance as ‘the ways in which suppliers of finance to corporations assure themselves of getting a return on their investment’ (p. 737).

Like others (i.e. Fama, 1980; Fama & Jensen, 1983; Daily, et al., 2003) they see corporate governance in an agency perspective, which has been the dominating theory in the study of boards and corporate governance. According to Daily, et al. (2003), there are two factors why this agency theory has been so important in the study of corporate governance. First, they argue that it is a simple theory that reduces complex corporations to only two participants, the shareholders and the managers, with both clear interests. Second, they argue that the notion that human beings are self interested and unwilling to give up their interest for another person, is believed widespread. However, empirical research in this mainstream of research has yielded ambiguous results, which has led to alternative theorizing in the research on boards (Van Ees et al, 2005). In the last decade, a growing number of studies has emphasized on processes and actual behaviour in and around the boardroom (Huse, 1998; McNulty &

Pettigrew, 1999; Forbes & Milliken, 1999; Westphal, 1999; McNulty, et al., 2005). Van Ees et al (2005) have provided an overview of the mainstream of traditional themes in corporate governance and the behavioural theories of boards and governance, which focuses on interaction and decision processes. The overview is depicted in table 1, in appendix A (Van Ees, et. al., 2005:29).

Insert table 1 about here

In the reminder of this section the existing studies and theories in the field of corporate governance will be outlined, by following the different entries of the table. Moreover, by describing the literature according to table 1, it will become clear where the study performed in this paper, the analysis of the impact of trust and power relationships on different roles of board members, can be positioned in a broader field of corporate governance studies.

Table 1 shows that corporate governance is dealing with internal and external relationships among various stakeholders and those relationships can concern structure, interactions and decision making processes. Internal relationships refer to relationships between stakeholders that operate within the organisation and are for example relationships between board members. External relationships refer to relationships with stakeholders, who seek to influence decisions, but do not actually take the decisions. An example of these relationships is the one with shareholders (Huse, 2000).

Structures and outcomes refer to the formal organisation and represent the mainstream of research, mentioned earlier. The growing number of studies with a behavioural perspective can be divided into studies on interaction and studies on decision making processes.

Interactions refer to the relationships among stakeholders, being involved in influencing the direction of the organisation. The decision making processes refer to the shaping and making of strategic decisions (Van Ees, et al., 2005).

The first entry (I) in table 1 concerns the agency theory, focussed on the principle-agent relationship between owners and managers in a corporation. Since owners and managers are assumed to have conflicting goals in the agency perspective, corporate governance mechanisms are developed, which can provide shareholders some assurance that managers will make an attempt to achieve outcomes that are in shareholder’s interests (Shleifer &

Vishny, 1997). These mechanisms include ‘an effectively structured board, compensation contracts that encourage a shareholder orientation, and concentrated ownership holdings that lead to active monitoring of executives’ (Daily, et al., 2003: 372).

The second entry (II) of table 1 is dominated by the transactions costs economic and contract theory, which regard the corporation as a network of contracts (Williamson, 1984, 1988). In order to structure the external relationships of the corporation corporate governance regulations has been designed. It concerns corporate governance legislation and national codes of corporate governance. As mentioned in the introduction of this paper 52 countries worldwide have such a code of corporate governance and more countries are stimulated to develop one.

The next entry (III) in the table concerns theories like the stewardship theory and the social exchange theory. These theories focus on how trust and power relationships affect

collaboration and conflict in the boardroom. McNulty & Pettigrew (1999) argue that the influence of strategy by part-time board members (and so which roles the board members are active in), is depending on several factors, including the relationship that exists between board members. A relationship can either enable or constrain the opportunity to influence strategy.

Westphal (1999) shows that a lack of social independence, so social interdependence can determine the role the board plays in the strategy-making process. His conclusion is that social ties will actually lead to board involvement through advice and counselling. This means that the relationship between board members will determine the board involvement in the strategy process of McNulty & Pettigrew (1999). Westphal (1999) focuses on the impact of friendship ties in particular between board members, with regard to the impact these ties have on the roles of monitoring, advising and counselling. He finds that friendship ties, that imply trust or the expectation of personal loyalty, will have a negative effect on the monitoring role and a positive effect on the role of advising and counselling. Another factor important in determining the social tie between board members is power of information (Westphal 1999), which in turn will effect the role of board members. When executives are seeking advice they have to disclose the existence of a problem and their own limitations of solving the problem.

And the other way around, for a supervisor to give advice he must be willing to disclose the information and knowledge he has on the issue in question.

The fourth entry (IV) in table 1 concerns mainly the resource dependency theory. From this perspective ‘effective boards link the organisation with its environment by establishing important contracts and providing access to timely information through personal and professional networks’ (Van Ees et. al., 2005: 8). Through these inter-organisational networks organisations try to increase their effectiveness.

Entry V in the table concerns the decision-making in and around the boardroom. In their study of understanding boards of directors as strategic decision-making groups, Forbes & Milliken (1999) make an attempt to better understand the behaviour involved in effective board performances. In their study they recognize the dual role of non-executive board members of control and support. To fulfil the control task, the board has to make decisions regarding the hiring, compensation and replacement of managers, as well as approval of initiatives proposed by managers. Activities as providing expert and detailed insights during major events are necessary to fulfil the support task. They come up with a model of (what they find) strategic

decision-making effectiveness in US-based boards. In this model they consider the influence of certain board processes (effort norms, cognitive conflict, use of knowledge and skills) on board effectiveness and come up with the following propositions: ‘(1) Board effort norms, cognitive conflict and the use of knowledge and skills will be positively related to board task performance. (2) The relationship between cohesiveness and board task performance will be moderated by cognitive conflict - that is, cohesiveness will be less likely to detract from board task performance when the board has a high level of cognitive conflict’ (Forbes & Milliken, 1999: 497). With regard to proposition one, it seems obvious that more effort of members will lead to a better performance. Cognitive conflict can be defined as ‘disagreement about the content of the tasks being performed, including differences in viewpoints, ideas and opinions’

(Jehn, 1995: 258). Cognitive conflicts will trigger alternative perspectives, so that the best decision can be made and therefore they will influence performances in a positive way.

Knowledge and skills can certainly lead to better performance, since board members have better understanding of the situation and the initiative of the executive and therefore they are able to make a better decision on the topic in question. With regard to the second proposition, cognitive conflict will not support cohesiveness and therefore it can harm trust relationships.

This can have an affect on the roles of monitoring and support the board members perform, since trust and emotion have found to be important in board behaviour (Huse, 1998). Like Forbes and Milliken (1999) also other studies have focussed on these two roles of monitoring and support (Huse, 1998; McNulty & Pettigrew, 1999; McNulty et al., 2005). McNulty &

Pettigrew (1999) developed a conceptual model to show that ‘part-time board members are able to influence processes of strategic choice, change and control by shaping both the ideas that form the content of a company’s strategy and the methodologies and processes by which those ideas evolve’ (McNulty & Pettigrew, 1999: 47). The model is shown in table 2, appendix B.

Insert table 2 about here

The model suggests that there are three levels of involvement in strategy of the part-time board members: taking strategic decisions, shaping strategic decisions and shaping the content, context and conduct of strategy. Moreover, the model suggests that decision-making with regard to strategy is the activity in which board members are able to have control over the executives by influencing them in their proposals. The influence can be achieved in three

possible ways. First, the executive is consulting the board members. Second, the executive is shaping his proposal in such a away, to anticipate the response of the board, so that approval of the proposal will be assured. Third, board members can deliberately try to ensure that a certain strategy is formulated by the executive, by encouraging him in a certain strategic direction. The ultimate activity board members can use to ensure a certain strategy is to fire a certain executive that is not going in the ‘right’ strategic direction. With this study McNulty and Pettigrew (1999) show that part-time board members are not only performing the monitoring role of controlling the executives, but are strongly involved in the supporting role as well. Instead of switching between the two roles, McNulty et al. (2005) argue that board members should create accountability through ‘challenging, questioning, probing, discussing, testing, informing, debating, exploring and encouraging’ (p.4) and find an effective combination of elements of both roles. They explore accountability in three sets of behaviours of the non-executive director: ‘engaged but non-executive’, ‘challenging but supportive’, and

‘independent but involved’. They find that through accountability the non-executive director can perform all of these behaviours and roles. Through asking questions the non-executive director could collect information about the firm to be engaged. However, the non-executive director must have the discipline to remain the non-executive to be of value for the executive.

Through discussions the non-executive director can challenge the executive’s ideas and through a culture of openness, which creates trust, the non-executive director can support the executive. With regard to the last set of behaviours, the authors conclude that the non- executive director should be involved with the executive but stay ‘independent of mind’, which is the key to effective board behaviour.

The last entry (VI) in the table concerns mainly the institutional theory. In this perspective the corporation is viewed as embedded in a broader institutional environment (Di Maggio &

Powell, 1983). Boards behave rather according to the norms, rules and expectations of the broader population they are operating in than that they behave in a way which increases the effectiveness of the corporation.

Research model and propositions

As mentioned in the introduction, the objective of this study is to gain more insight in the actual behaviour in and around the boardroom and therefore can be positioned in entry III and V of table 1. More precisely, this study will focus on the impact of trust and power

relationships (entry III) on the roles of the board members (entry V), which is shown in the research model in figure 1, appendix C.

Insert figure 1 about here

In the reminder of this section the different element of trust and power will be discussed, which will lead to several propositions.

Trust. Cohesion is found to be important in relationships of trust (Forbes & Milliken, 1999).

Cohesion can be defined as ‘the degree to which members of a group are attracted to each other’ (Shaw, 1981: 213). Research shows that members of cohesive teams show higher levels of affinity and trust for one another (Ensley, et al., 2002). This means that when the supervisory board and the executive board feel both committed to the same team (the organisation) cohesion can appear and relationships of trust can exist between members of the board. Lee & Choi (2003) define trust as ‘maintaining reciprocal faith in each other in terms of intention and behaviours’ (p.190). When people trust each other, they are more willing to share information and therefore supervisory board members can influence executives through the information they give to them. Huse (1998) found in his study that trust cannot be taken for granted in relationships between board members. Trust is dependent on the perception of one person of the ‘competence, capacity, timing, even the integrity, good intentions or reliability’ (Huse, 1998: 222) of another person. However, all these mentioned determinants of trust are actually determinants of trustworthiness, according to Gillespie (2003). She argues that trustworthiness is a condition for trust, but both concepts are not the same. According to her, central to the concept of trust are the ‘willingness to be vulnerable’, risk and interdependence. This is in line with the definition of trust proposed by Mayer et al. (1995):

‘Trust is the willingness of a party to be vulnerable to the actions of another party based on the expectation that the other will perform a particular action important to the trustor, irrespective of the ability to monitor or control that other party’ (p.712). In her research, Gillespie (2003) develops a model for measuring trust and identifies two domains of trust.

The first is reliance, which is reliance on skills, knowledge, judgement or actions of another person. The second domain is disclosure, which is sharing professional or personal information of a sensitive nature. The two domains of trust are measured with the concepts trustworthiness, distrust, relationship strength, common values and goals, satisfaction with

performance, relationship effectiveness, disposition to trust and overall trust. The results of her study showed that the two domains of trust will lead to a stronger relationship between members and more interdependence in the relationship. This confirms the conclusion of Westphal (1999) that trust will enhance social ties of friendships and will determine the role of board members. It will lead to a less monitoring role and more advising and counselling, which is the supporting role. Therefore, with regard to the roles of McNulty & Pettigrew (1999), discussed above and depicted in table 2, trust and friendship ties will lead to involvement of the non-executive board in shaping strategic decisions. From this the following propositions can be drawn:

P1a: Reliance and disclosure, the two domains of trust between board members will enhance friendship ties between board members.

P1b: Friendship ties between board members will lead to more involvement in the role of shaping strategic decisions, through the activities of advising and counselling.

Power. Power can be used as a strong mechanism to influence other people (Morgan, 1997).

Morgan (1997) argues that power can be viewed as a social relation, characterised by some kind of dependency and therefore ‘power involves an ability to get another person to do something that he or she would not otherwise have done’ (p.171). Some of the sources of power that supervisory board members can use to influence are formal authority, control of decision-making processes and control of knowledge (Morgan, 1997). The first one, formal authority, is the most obvious one in every organisation. The supervisory board can insist on correct application of formal rules and procedures (i.e. the code of corporate governance). In this way they exercise formal power over the executives. Second, control of decision-making processes is a source of power the supervisory board has. Supervisors can influence executives in their initiatives before the decision is actually taken by the supervisory board.

Furthermore, executives can ask advice to the supervisors, so that they can be almost sure of approval of their proposals. The last source of power is the knowledge. The supervisory board consists of experts in the field of their education or primer work experience (Moerland, 1995).

These experts can use their knowledge to influence executives by giving them advise and the possibility of consultation. Pettigrew & McNulty (1998) performed a study about the sources and uses of power used by part-time chairmen and non-executive directors in the boardroom in the UK. They state that the ability of exercising the monitoring role effectively is

dependent on the power position of the non-executive directors towards the executives. Since the introduction of the code of corporate governance in 1992 in the UK there is evidence that the structural power of the non-executive directors grew, which should lead to a larger engagement in the monitoring role. However, as stated above McNulty & Pettigrew (1999) also found evidence for greater involvement in strategy of the non-executives, which leads to the advising and counselling roles. Therefore, they argue that the sources of power are often structurally embedded (i.e. in a code of corporate governance), while the uses of power lie more in the interpersonal relationship between members of the board. They conclude that for the use of power it is important to have personal and interpersonal qualities of will and skill, to turn a receptive context for influence and a set of power sources (i.e. experience, prestige, positional power, access to people and information) into actual influence in the strategy shaping process (Pettigrew & McNulty, 1998). Therefore, the actual use of power depends on the availability of power sources to board members, the willingness of board members to use the power sources they have and the skills in exploiting those sources. When power is actually used it can lead to closer involvement in the shaping of strategic decisions or in the shaping of the content, context and conduct of strategy, because executives can be influenced by the knowledge of non-executives through advises and consultation. Moreover, they found that when the use of power increases the extent of trust between board members will decrease.

The following propositions can be drawn:

P2a: The availability of power sources and the will and skills of a board member together will enhance the use of power between board members.

P2b: The use of power will lead to more involvement in the role of shaping strategic decisions, through the activities of advising and counselling.

P2c: The use of power and the extent of trust will be negatively related to each other.

Monitoring role. In several studies above described, the dual role of monitoring and supporting was recognized (i.e. Huse, 1998; Forbes & Milliken, 1999; McNulty & Pettigrew, 1999; Daily, et al., 2003; McNulty, et al., 2005). The Dutch code of corporate governance states that the supervisory board should be independent from the executives, so that the monitoring role can be fulfilled and board’s strategy will be more effective. Contrary to this conclusion, Van Ees et al. (2004) argue that the effectiveness of board’s strategy is actually enhanced when supervisory board members are more involved in the process of strategy,

thereby fulfilling the supporting role. To realise this closer involvement there needs to be interdependency between the supervisory board and the board of management (instead of independency) which could reduce the ability of supervisors to monitor objectively. McNulty et al. (2005) conclude as well that there needs to be a certain involvement of the non- executives and therefore interdependency between non-executives and executives, in order to collect the necessary knowledge about the corporation, so that they can monitor the work of the executives effectively. They argue that it does not affect the monitoring role in a negative way. The following propositions can be drawn from this:

P3a: Assuming that the corporation in the case study will apply the code of corporate governance, in terms of having an independent supervisory board, the actual board behaviour will show interdependency between the supervisory board and the board of management.

P3b: Interdependency, in terms of knowledge, in the relationship between board members will lead to a closer involvement of the non-executives in the role of shaping strategic decisions, through the activities of advising and counselling.

P3c: Closer involvement of the non-executives in the role of shaping strategic decisions, through the activities of advising and counselling, does not negatively affect the monitoring role of non-executives.

RESEARCH DESIGN

Motivation of the case study method

This study will be an empirical research carried out through a single case study of a corporation listed at the Dutch stock exchange. There are several reasons for choosing the case analysis method. According to Eisenhardt (1989) a case study is a research strategy, which focuses on understanding the dynamics present within a certain setting and it can be used to provide description or generate a theory. In this study both will be done. First of all, this study will describe the roles the board members play in the strategy process. Moreover, the study will explore the impact of trust and power relationships on those roles, which can lead to a new theory. The second reason why the method of a case study is chosen is because

it is suggested that an emergent theory is likely to be empirically valid as it has been build up through intimate interaction with the reality (Glaser & Strauss, 1967; Gill, 1995).

A potential weakness of this study is that a single case will be studied. Eisenhardt (1989) argues that it can lead to generating a theory, but it may lack the possibility to generalize a theory. In this study this weakness will be overcome by comparing the results of this single case to the results of cases in the UK (McNulty et al., 2005). This approach will enhance the reliability of the results of this study of a single case.

Data collection method

In most case studies a combination of data collection methods, such as archives, interviews, questionnaires, and observations, is used (Eisenhardt, 1989). Multiple data collection methods can provide stronger evidence of constructs and possible hypotheses. Also in this study a combination of data collection methods will be used. The first one is interviews. The weakness of this method is that it will provide mostly perceptions of board members on how they see their relationships with each other and the roles they are performing. Therefore, also other methods like observation and data from written documents of the company will be used.

However, it should be recognized that some caution is needed in stating conclusions, since the interview method is the main data collection method in this study and therefore provide most of the results.

To collect the data for describing the roles of the board members in the case, the method of interviews will be used. This method will provide qualitative data, but mostly perceptions of the board members on the behaviour of the board members in the strategy process and the roles they play in this process. Moreover, the interviews will be used to make un attempt to uncover the existing relationships between the board members. An attempt will be made to uncover trust relationships and power relationships and the impact they have on the roles of the board members. Since the company used in this case study has a two-tier board system, two different interview schemes were made; one for the members of the supervisory board and one for the members of the board of management, since they are supposed to perform different roles. Both schemes are included in the appendix of this paper under section D and E. The interview questions were drawn from several studies done on the topics of relationships, roles, trust and power, as described in the forgoing section. The first part of the

interview questions, the relationships and roles, is drawn from the study by Westphal (1999), in which he tries to discover the different relationships between members. He distinguishes between monitoring, advice and counsel interactions and friendship ties. The interview questions with regard to the advice and counsel interactions are drawn from the three roles McNulty and Pettigrew (1999) come up with in their study; taking strategic decisions, shaping strategic decision, and shaping the content, context and conduct of strategy. The interview questions with regard to the friendship ties are drawn from the study of Gillespie (2003), in which she studies trust in relationships. Therefore, also the questions on the topic of trust in the interview are drawn from the study of Gillespie (2003). The interview questions on the topic of power are drawn from the power sources of Morgan (1997) and from Pettigrew and McNulty (1998) who find that the will and skills to use power are important in the actual use of power. All the interviews were taped and transferred into written documents so that data analysis was possible.

To find more evidence on the roles of supervisory board members and relationships between supervisors and executives, observation will also be used as a data collection method. A supervisory board meeting of all board members will be observed and it will provide more information on questions as who is taking final decisions, does everyone agree on it and is someone using power to force a decision, etc. The observation scheme used is included in appendix F.

The third data collection method used in this study is the collection of data out of the annual report of the company and the website of the company. This data will be collected for the analysis of appliance of the code of corporate governance by the company, focussed on the topic of independence of the supervisory board. The reason for using the annual report and the website is that the code is prescribing that the information with regard to the appliance with the code should be presented in public available sources of the company.

Data analysis method

With regard to the qualitative data, acquired through the interviews, the main method of analysis will be the text analysis. By looking for evidence of actual board behaviour in the different answers of the members on the interview questions, conclusions can be drawn about the roles of board members in the strategy process and the relationships that exist between

members, in particular the ones of trust and power. Moreover, the propositions drawn from the literature above can be evaluated for being either supported or rejected. The observation data will be used to strengthen the conclusions derived from the interviews.

Another part of the analysis will be analysis of the appliance of the code of corporate governance by the corporation of the case study, focused on the topic of independency of the supervisory board. Therefore, a part of the so called ‘evaluation list’, made by a group of researchers, in which I am participating, at the Rijksuniversiteit Groningen, will be used. The methodology used within the ‘evaluation’ is depicted in figure 2, in appendix G.

Insert figure 2 about here

The model is following the ‘evaluation list’ in the sense that every best practice of the code of corporate governance is formulated in a statement. This leads to the result that the company is applying the statement or it is not, which leads to the first level in the model. For certain companies a few best practices will not be necessary to apply, because of for example the size of the supervisory board. Therefore, an option of ‘best practice is not applicable’ is included in the model. In the introduction of this paper, the rule of the code ‘comply or explain’ was already mentioned and this is depicted in the second level of the model. It means that if the company does not comply with the code but explains why, the company is indirectly applying the code. When a best practice is complied with, it can still be in two ways. First, the company is not saying anything about the best practice. According to another rule of the code the company is then implicit complying with the code. Second, the company is complying with the code and this can be found in an information source of the company like the website or the annual report. With this list, conclusions can be drawn about the extent of appliance of the company of the case study and about what changes are still be necessary to achieve a higher compliance rate.

This analysis of appliance of the code by the company will be compared to the actual behaviour of the board members, found in the analysis of the interview and observations, in particular on the topic of independency, to find out whether the code of corporate governance will lead to the same conclusion on the topic of independency as the results of this study do.

Moreover, a comparative analysis will be conducted between the results of this study on the roles of board members and the impact of trust and power relations on these roles and the results of the study of McNulty et al. (2005), to find out if the behaviour within boards is affected by the national context. In this study the national context will be determined by the code of corporate governance, which differs between countries in the fact that companies are viewed in the light of a one- or a two-tier structure. However, it should be noted that national context can be determined by other factors, only than the code of corporate governance. One of those factors is the labour relation system of a country, which differs between The Netherlands and the UK, which could have an effect on the behaviour within boards.

However, due to the fact that the question which structure, a one-tier or a two-tier structure will lead to more effective functioning of boards and the question if it could be the actual behaviour of board members that is determining the effective functioning of boards, instead of the structure, are very much discussed nowadays, I’ve chosen to focus on this factor determining the national context.

CASE STUDY

In this section the background of the company in this study will be described. It will focus on the history of the company, the financial performance and the background of the members of the board of management and the supervisory board.

Company background

The history of this company goes back to 1967, when the company started to develop activities in electronic equipment, which led to the official start of the company in 1968. Over time the activities of the company where diversified, when the company started to test equipment for other companies. Moreover, the company also started to write the necessary programming software for testing. Since these activities became more and more important, it had as a result that they became more diversified from the activities of the mother company.

Therefore, the subsidiary with the testing activities started as an independent company in 1979. Nowadays, this company fulfils the role of supplying products and services to the European semiconductor industry. The core activities of the group are testing and analysing the quality and reliability, as well as developing test software. Those activities are divided in

test and related services (62 % of the turnover in 2004), production support services (31 %) and equipment sales (7 %). However, the part ‘equipment’ has been ended in the first half year of 2004. Major customers operate in the semiconductor industry. Moreover, the company is active in the telecommunication industry, automotive industry, electronic industry, and the sector of consumer electronics. Due to problems within the company and an enormous setback in the whole semiconductor market, the company has only one operating unit in Germany at the moment. However, the company is looking for growing opportunities in new markets and locations in Europe and the Far East.

The fact that the company is quite small at the moment has as a result that the board is small as well, consisting out of five members. As a consequence it might be more easy develop trust relationships and friendship ties, due to the fact that staying in contact with one another is easier than in the situation that the company was bigger with a larger amount of board members.

Financial performance

In the book year 2004 the company had a net-turnover of EUR 7.8 million, against EUR 8 million in 2003. The increase in turnover of the parts ‘testing’ and ‘production support services’ could not totally compensate the decrease in turnover of the part ‘equipment’. The net-profit decreased from EUR 773.000 in 2003 to EUR 19.000 in 2004. However, in 2003 there were some special assets/profits. If these were kept out of the picture, there would have been a profit increase. The equity of the firm decreased in 2004 from EUR 3.2 million to EUR 3.1 million. The company is expecting an increase in the profitability in 2005. More financial figures are drawn in figure 3, appendix H.

Insert figure 3 about here

As one can notice from figure 3, the company experienced a difficult period in the past five years, with ever decreasing operating income and profits. However, 2004 shows an increase in operating income again, which shows the start of the recovery of the company. This recovery can result in a growth of the company in the future, which will eventually result in a larger board with more members. When the number of members will grow it might be more

difficult to stay in contact with one another, which could impact relationships of trust and power.

Composition of the board of management

The board of management consist out of three members. The first member is a male, born in 1945. His nationality is Dutch and he is fulfilling the function of CEO within the company.

He was appointed in September 2004. He has a degree in Mechanical/ Industrial engineering and has had several former work experiences in the business area of this company. The second member is a male born in 1954 and his nationality is German. He studied Electrical engineering and Cybernetics. After his graduation he started to work for this company as an engineer. Nowadays, he is fulfilling the position of managing director of the operation in Germany and the position of CTO. The third member of the board of management is female.

Her nationality is Dutch. She studied accountancy and she was appointed to the company in 2005 as CFO.

Composition of the supervisory board

The supervisory board of the company consist of two members. The chairman is a male with the Dutch nationality. He was born in 1936. He graduated as a mathematical engineer and his profession is management consultant in the electronics industry. He has former work experience within one of the biggest companies in the business of the company in this case study. He was appointed as supervisor in 1998. The second member of the supervisory board is a male born in 1944. He also has the Dutch nationality. He studied electro techniques and started to work for the company of the case study. Thereafter, he worked for some other companies in this industry and nowadays he is the managing director of an investment company. (This investment company invested in the company of the case study during the financial restructuring of the company in 2003.) In 2004 he was appointed as supervisor for the company of the case study.

Due to the fact that several of the board members are appointed to the company recently, trust relationships and friendships ties may not have developed yet, since it takes time to develop such relationships.

RESULTS

In this section the results of the analysis of the interviews and observation data will be depicted. First of all, the behaviour of the board members will be described with the focus on trust, friendship and the use of power in the relationships between the board members.

Thereby, the propositions 1a, 2a and 2c will be examined. Secondly, the roles of the board members and especially the involvement of the supervisors in the process of strategy will be described and thereby examining proposition 1b and 2b. In the third place the comparison between the appliance of the code of corporate governance by the company, focused on independency and the actual board behaviour will be described. Thereby, proposition 3a, 3b and 3c will be examined.

Board behaviour with regard to trust relationships

The focus of the analysis with regard to trust relationships was on the trust between the supervisors and the executives. From the analysis of the interview data, trust in the relationships between supervisors and executives was found to be moderate, since some results showed low levels of reliance (determinates trust (Gillespie, 2003)), while other results showed high levels of disclosure (determinates trust (Gillespie, 2003)). Low levels of reliance between the board members of the supervisory board and the board of management were shown by the fact that the supervisors never take the judgement of the executives about a strategic proposal for granted. They always ask further questions and are discussing the proposal before coming to a decision. One of the executives remarked:

‘They [the supervisors] want to know everything, definitely. Sometimes you have the feeling that it is too much, that you have explained it ten times to different people, with three different translations. The discussions are on every topic of the proposal, on a technical base, a customer base, a financial base, return of investment etc. When it is a proposal with a big chance of risk, the questions are even tougher. But also about small proposals without risk, questions are always asked.’

Another executive confirmed that:

‘They [the supervisors] never take your opinion for granted; they will always ask critical questions.’

The chairman of the supervisors remarked:

‘I will always ask further questions, trying to understand where the proposal is really about. I want to understand how the executive thinks and why he thinks this way.’

The results from the observation of the meeting of the supervisory board also showed that about every topic on the agenda questions were asked resulting in a discussion. One of the supervisors later even mentioned that in his opinion there were only a few discussions during the observed board meeting, while normally the discussions can be much tougher and deeper on the topic.

The reliance, and therefore trust was also measured by on the one hand the question if executives actually follow the advice of the supervisors and on the other hand by the trust of supervisors that the executives will ask for help, when needed. The results show that the executives in the case study usually ask for advice when they think it is necessary. However, when they think they do not need advice the executives will not ask for it. Moreover, the advice isn’t always followed by the executives, which results in a moderate level of reliance.

One of the executive remarked:

‘I have no problem admitting a problem and ask for advice, when I need it. However, when I don’t need advice I won’t ask, because in that case you run the risk of getting a different advice, and that is very irritating.’

About the fact that advice is not always followed, one of the supervisors remarked:

‘I don’t know if the executives are always following my advice. I think in general they look at least in the direction of the advice. However, they aren’t always following it. They listen to it and when they don’t agree with it, they explain me the reason why and most of the time I see then why the advice was wrong.’

The results show that members are sharing personal feelings among each other and show that the members of both boards easily reveal information and opinions and share them with the other members. Therefore, the level of disclosure was found to be high. One of the executives remarked:

‘Before the meetings we always speak with each other about how one person is doing. Moreover, I travel a lot with the other executive to Germany and of course we speak about personal things, like family.

All of the members remarked that they always give their opinion in discussions. This was confirmed by the observation results, which showed that all of the board members participated in the discussions. Moreover, all the executives remarked that they inform the supervisors about their proposals before the actual proposal is brought to the official meeting.

‘I usually inform the supervisors very well. … There is every week contact with one of the supervisors to speak about what is going on…’

The supervisors remarked that they both give their opinion easily and share their knowledge with everyone.

‘I won’t hesitate to give my opinion, sometimes very undiplomatically of me. … I’m always willing to share my knowledge on a topic with the executives.’

With regard to the topic of friendship ties, the results show that these ties do not exist between the board members. They meet each other almost always on a professional base and rarely meet each other on personal base. None of the board members considers another member as a real friend. (However, some of them also mention the fact that the time that they work together is too short for developing a friendship tie.) Moreover, one of the supervisors mentions that friendship would not be good for the business:

‘Of course it is possible [to have a friendship with another board member], but I don’t believe in that. The essential point is that you have to remain focussed on the business. When there is too much friendship in the relationship, you are losing your objective judgement. You cannot keep a person that is not functioning well in the business, because he is your friend.’

One of the executives confirms this. On the question how many of the board members he considers as his friend he answers:

‘Are there friends in business? I think friendship is dangerous in business, because when you rely to heavily on friendship, you lose the focus of business and responsibilities. … Of course it is possible to have friendship relationships with board members, but you should keep that separate from business. I repeat, too much friendship could be dangerous.’

In short, the results show a moderate level of trust between the members of both boards.

Moreover, according to the members of both boards, there are no friendship ties between them. With regard to proposition 1a, these results show that no or moderate trust will not enhance friendship ties. However, with these results nothing can be said about if trust will enhance friendship ties. Therefore, the proposition cannot be accepted nor rejected.

Board behaviour with regard to power relationships

The results show that the supervisors have the sources of power mentioned in the research model. First, they have the source of power of formal authority. The executives recognize the fact that the supervisory board stands above them formally and they regard the supervisors as persons with a certain status, because of former work experience. The chairman of the supervisory board answers the following on the question, which person has the biggest amount of power:

‘When you look to the letter of the law, of course it is me…’

Second, also the source of power of the supervisors with regard to the decision-making is recognized by the executives. One of the executives remarked:

‘I always inform the chairman about my proposals and ask for his opinion, because when he disapproves, it is no worth going on with it anyway.’

The third source of power, knowledge and information can be used by both boards. The results show that the supervisors have knowledge based on former experience, which is recognized by the executives and the executives have the information about the proposals and about what is going on in the company.

However, the actually use of power shows to be low, mostly because the will to use power lacks. All supervisors and executives remark that they reveal their knowledge and information easily to each other and therefore are not using the power source of information. Moreover, they all remark that decisions are taken all together and decisions are rarely taken by the supervisors or the chairman only. None of the members has the feeling another member is trying to force a decision, thereby using power.

With regard to proposition 2a, the results show that the availability of power sources alone is not enough for using power. The supervisors are having power sources available to them, but are not using them, because the willingness to use them lacks. This shows that the will to use power is definitely important for the actual use of power. Therefore, proposition 2a can be accepted.

The results described above show that trust was found to be moderate and the use of power was found to be low. This implies that trust and power are not negatively related to one another, which leads to rejection of proposition 3c.

Board Roles

According to McNulty and Pettigrew (1999) the involvement of the supervisors (in their study the part-time board members, due to a one tier board system can be on three levels: taken strategic decisions, shaping strategic decisions, and shaping the content, context and conduct of strategy. The results in this case study show that the supervisors are on the first two levels of involvement, but they are rarely involved in the process of shaping the content, context and conduct of strategy. The supervisors and the executives all remark that the executives need to shape the strategy and so need to come up with specific proposals on how to give form to the strategy of the company. One of the executives remarked:

‘The idea is that the executives are responsible. We are running the show and the supervisors are advising or preventing us from making big mistakes. They do not run the business. That is not the idea. Sometimes they want to go to a certain direction, but then it is our choice to say: ‘Okay, but I have to do it.’ Maybe I have a different opinion, because their knowledge is old or from another company and most of the time my opinion is accepted then. They want us, the executive guys to run the show.’

Later in the interview he remarked:

‘The supervisors are almost never involved right from the beginning, there should be a certain framework of a proposal, before we contact them.’

One of the supervisors confirms that:

‘My job is participating in the rules setting, so about what we are going to do and how we are going to do it.

However, the initiative is always coming from the executive, the CEO. He needs to do it and so he needs a certain level of freedom to do it.’ …. ‘The CEO we have now has a creative spirit and takes initiatives by him self. So there is no need for me to start initiatives, my role is more monitoring and controlling and leading discussions.’ … ‘The game needs to be played by the executives, so when you ask me if I’m a coach, well I don’t know, maybe but I think that is already too involved. I try to keep a certain distance.’

The involvement of the supervisors in the shaping of a strategic decision, the second level of involvement, is confirmed by the fact that the executives almost always ask advice about a proposal or at least inform the supervisors before the proposal is discussed at a meeting. One executive remarked:

‘The opinion of the supervisors is never new at a meeting; there is always a history, because there is always earlier contact about a proposal.’

Both supervisors confirm that they see their task of monitoring as very important. One of the supervisors remarked:

‘My major job is controlling if the strategy that the executives form, is the strategy in the way they say they form it. Of course I need to see if the plans are realized and if it is in a way that we agreed on. Every month we get a report of the executives and then I can see in which direction it will go. When I find something special I call them to ask more about it’

The other supervisor remarked:

‘Important in my job is controlling the performance of the executives. As supervisor you need to have the ability to see red flashing lights, when you feel things are not going the right way. Then I take the phone and ask for explanation.’

One of the executives explains the way the supervisors monitor him:

‘First they control and verify the content of the numbers in the report. Secondly, there are targets agreed on and they check if these targets are achieved or not. Thirdly, they are controlling my work in every way by informal conversations. And with this, I mean informal conversations about me between the supervisors and the other executives.’

In short, these results show that the role of the supervisors is very much the one of monitoring. Moreover, they also perform the supporting role in giving advises to the executives, but the level of involvement remains there. The supervisors are not involved in the role of shaping the content, context and conduct of strategy. With regard to proposition 1b these results show that there aren’t friendship ties between the board members, although the supervisors are involved through activities of advice and counselling. Therefore, these results neither reject nor confirm this proposition. The same holds for proposition 2b. Since power is not used in this case study, the proposition cannot be supported nor rejected.

Independency and interdependency

In this part the result of the appliance of the code of corporate governance by the company, and then especially on the principle of independency of the supervisory board, will be compared with the actual results of board behaviour. The code of corporate governance prescribes that the supervisory boards should be composed of members that are independent of each other, the board of management and any other issue of interest, so that they can operate objective and critically. Maximal one supervisor of the board is allowed to be dependent. The code is prescribing criteria of dependency, so a supervisor is said to be independent if these criteria are not applicable to him. In the case of the company in this case study, one supervisor is remarked not to be independent, since he is the managing director of an investment company that invested in the company of the case study during the financial restructuring. Therefore, this supervisor has an important business relationship with the company of the case study, which is one of the criteria of dependency. The other supervisor is remarked as independent and therefore the company is applying the code of corporate governance, since only one member of the board is found to be not independent. However, it should be taken in mind that although the company is applying the code, the supervisory board only consists of two members and so 50 percent of the supervisory board is not found to be independent, which leads to certain situations, in which only one supervisor can monitor objectively.