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THE RELATIONSHIP BETWEEN BOARD STRUCTURE, BOARD DIVERSITY AND GOOD CORPORATE GOVERNANCE

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By: Gerda de Jong S 1550459 Supervisor: Prof. dr. D. Swagerman Second supervisor: …. Business Administration: Organizational Management and Control

THE RELATIONSHIP

BETWEEN BOARD

STRUCTURE, BOARD

DIVERSITY AND GOOD

CORPORATE

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1 Preface

This document is the result of a research conducted in order to complete the master program Business Administration: Organizational Management and Control. In the past year I have researched the relationship between board structure, board diversity and good corporate governance. All three items have received considerable attention in the recent past, which made the research even more interesting to me. Although drawing definite conclusions and making recommendations on this topic proved to be difficult, I have learned much during the writing of this thesis and I have enjoyed discussing the subject with many people.

I would like to thank my supervisor for his time and feedback during the writing process of the thesis and conducting the research. Additionally, I would like to thank all the interviewees that contributed to this research by providing me the opportunity to ask them questions about their view on this topic. The interviews provided me with an opportunity to gain both in-depth knowledge of the subject matter and discuss my findings with experts, which was very interesting. Furthermore, I would like to thank Laurens Timmer and Joliene van Grieken for their help and support during the writing process. Finally, the support of my family is much appreciated and helped me to finish this project.

This thesis marks the end of my time as a business administration student at the University of Groningen. It took some time and effort to finish this master thesis, but I am glad with the end result and am looking forward to starting my professional career.

I hope you will enjoy reading this thesis and gain new insights from it. Yours sincerely,

Gerda de Jong

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2 Abstract

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3 Table of Contents 1. Introduction 5 2. Research design 7 2.1. Problem statement 7 2.2. Conceptual model 9 2.3. Methodology 10

2.4. Restrictions and prerequisites 11

2.5. Structure of the research 11

3. Literature review 12

3.1. The importance of good corporate governance 12

3.2. Good corporate governance, board diversity and independence 13 3.3. Identifying elements in board composition relevant for good

corporate governance 15

3.3.1. Diversity in the age of board members 16

3.3.2. Diversity in the gender of board members 17

3.3.3. Diversity in nationality and ethnicity of board members 19 3.3.4. Diversity in educational background and expertise of

board members 20

3.3.5. Insider/outsider ratio 20

3.4. Structure of the firm: differences between the one-tier and the

two-tier board 21

3.5. The relationship between board structure, board diversity and

corporate governance 23

4. An analysis of the composition of the board in Dutch firms 24

4.1. Age diversity 24

4.2. Gender diversity 24

4.3. Diveristy in nationality and ethnicity 24

4.4. Diversity in educational background and expertise 25

4.5. Insider/outsider ratio 25

5. Interviews 27

5.1. Preparing the interview 27

5.2. Interview with Huub Willems 28

5.3. Interview with interviewee X 29

5.4. Interview with Max van der Sleen 30

5.5. Interview with Nick van Ommen 31

5.6. Interview with Bart Bierman 32

5.7. Interview with Hans van Grieken 33

5.8. Interview with Geert Raaijmakers 36

5.9. Interview with Charlotte Insinger 36

5.10. Interview results 38

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6.1. Relationship between board structure and board diversity 39 6.2. Relationship between board diversity and firm performance 39

6.3. Enforceability of board diversity 40

6.4. Relevance of the age criterion 41

6.5. Relevance of the ethnicity criterion 41

7. Conclusion 43

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5 1. Introduction

In the field of management research the composition of the board of directors of a company has been a returning topic for years. Many researchers have investigated whether (certain aspects of) board composition influences firm performance. Additionally, there has been an ongoing debate on the ideal composition of the corporate board both by practitioners and academics. Already in 1998 Dalton et al. established that in general neither board composition nor board leadership structure could consistently be linked to the financial performance of a firm. On the other hand, lawmakers do still design new regulations setting standards for board structure. The goal of these regulations is not necessarily to improve financial performance but usually its aim is to improve the corporate governance of firms. Since both board composition and board leadership structure have been researched with regard to the financial performance of a firm, the question arises whether these two variables could influence each other. Furthermore, if this is the case, what influence does this have on the design of a firm’s corporate governance regime?

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7 2. Research Design

This chapter outlines the research design and the methodology chosen to perform this research. First the research problem will be described, defining the objective of the research. This research problem leads to a main research question, which is in turn operationalized by several sub-questions. The problem statement also sets out the explorative nature of the research. Following, a conceptual model is provided, giving insight in the relationships this research tries to explore. Finally, the research method is described and limitations are defined.

2.1. Problem statement

Research objective

Board diversity has become a relevant and much researched topic in international business analysis. Much of this earlier research consists of choosing one or multiple variables of diversity and then testing which impact this variable has on a performance indicator, mostly using financial performance indicators. The results of these inquiries are often mixed and no general conclusion can be drawn. However, initiatives towards more board diversity are common, whether initiated by government, investors or the firm itself. Although the mixed research results do not specifically call for more board diversity, the general consensus seems to be that a more diverse board leads to higher independence and better supervision. This both decreases agency costs and should increase firm performance, while leading to a better corporate governance system within the firm. It is however unclear how diversity is influenced by the chosen board structure of a firm. Thus the question arises which board structure is more suitable to promote diversity amongst board members, the one-tier board system in which executive and non-executive board members function in the same board, or the two-tier board system where executive and supervisory boards are strictly separated. Since January 2013 firms in the Netherlands are allowed to choose themselves whether they prefer a one-tier or a two-tier board structure, thus providing us with a good example to research this topic. The goal of the research thus is to explore what influence certain elements of board diversity have on good corporate governance and how the one-tier board system influences this diversity, using the recent changes in the Netherlands as case subject and hopefully discovering further paths for research concerning this topic.

Research question and sub-questions

The aim of this research is to investigate whether board structure, and then more specifically the one-tier board structure, influences board diversity and good corporate governance. The main research question of this paper reads as follows:

Does a one-tier board structure lead to better corporate governance by increasing board diversity?

This research question can then be translated in sub questions that are derived from the research question in a deductive manner, being:

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The concept of good corporate governance must first be explained and it must be determined what constitutes good corporate governance in the context of this research.

- Which elements of board composition are relevant for good corporate governance?

Board composition consists of multiple elements or characteristics. Those element that are relevant for determining good corporate governance must be distinguished and explained.

- Does diversification of these elements lead to better corporate governance?

When the elements that are important for good corporate governance are distinguished, it must be researched whether diversification of these elements could indeed lead to better corporate governance.

- Does a one-tier board structure lead to more diversification in (each of) these elements?

When diversification of those elements of board composition that are important to good corporate governance is established and explained, the question remains whether the one-tier board structure is able to positively influence this diversification.

Nature of the research

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9 2.2. Conceptual model

The conceptual model describes the relationships between the variables that are researched in this research. It provides the reader with an insight in the relationships that are considered to be the starting point of this research.

Figure 1: conceptual model

As can be seen in the conceptual model, the expectation underlying this research is that a good corporate governance system is (amongst others) influenced by several variables of board diversity. This research investigates whether the one-tier board structure has a positive influence on corporate governance, by investigating the influence of the board structure on the different variables of board diversity.

Operationalization of variables

Board diversity: the degree to which members of a board have differing characteristics, backgrounds and experiences, measured by the variables age, gender, expertise and education, nationality and ethnicity and insider/outsider ratio;

Age: the age of board members, described in years; Gender: the sex of board members;

Expertise and education: the field of work, work experience and highest received educational degree a board member has received in the past;

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Insider/outsider ratio: the number of board members that have ties with the firm, have previous work experience within the firm or have work experience in firms related to the firm; Corporate governance: the creation of shareholder-value in the long run, whilst preserving the interests of the other parties that hold a stake in the firm, as can be influenced by the supervisory board.

2.3. Methodology

This research is designed to form a starting point in the investigation of the influence of the one-tier board structure on board diversity and, following, on good corporate governance. In this research, only a small part of corporate governance is researched, namely that part of corporate governance that can be directly influenced by or through the supervisory board. In order answer the research question, this research is divided into two parts.

The first part of the research is a literature study, which describes the importance of good corporate governance, what constitutes good corporate governance, which elements of board structure influence corporate governance, and how diversification of these elements influences corporate governance. The literature study encompasses past journal articles, books and other sources that have been published on this topic worldwide and has a descriptive character.

The second part of the research specifically focuses on the Netherlands. Due to the entering into force of the Dutch law ‘Wet Bestuur en Toezicht’, the Netherlands provides fertile grounds for investigating the influence of board structure on the diversification of board characteristics. Yet due to the short time that has elapsed between the implementation of the ‘Wet Bestuur en Toezicht’, this part of the research has a more explorative character and could serve as the starting point of a more longitudinal research project. This part first consists of an analysis of available information on board diversity in the Netherlands in past years. Some firms were already able to switch their board structure to the one-tier board structure due to certain exemptions in the Dutch legislation, whilst at the same time diversity encouraging laws have been adopted. The analysis thus shows trends in board diversity in the past years in the Netherlands.

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11 2.4. Restrictions and prerequisites

Every research has its restrictions and so has this research. First of all, this research is limited by time constraints and by the fact that this research is conducted by one master student. This research thus does not pretend to be a complete and comprehensive overview of the research topic, but must be seen as exploring the subject and establishing paths for further research. The articles used for the literature review are scientific articles, but limitations may arise from the scope of the topics, thus influencing the completeness of the literature review. This restriction also applies to the analysis of past trends, which is based solely on already existing data, this in light of the time restrictions and the availability of data. Next to that, the small number of interviews poses problems in such a way that it is difficult to identify whether the opinions of the experts are indeed shared by a larger public or are merely personal views on the topic that stem from a certain bias. In order to increase the validity of the interviews, only persons were interviewed that are indeed considered to be experts on the topic, either by possessing academic status or having (extensive) field experience. Finally, although the literature review has a global scope, the analysis and interviews are limited to the Netherlands and thus the outcomes of the research are only applicable to the Netherlands.

2.5. Structure of the research

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12 3. Literature review

There is a large amount of literature available concerning corporate governance, board structure and board composition. This chapter represents the state of the art of the literature concerning the research topic and as such functions as a delineation of the research. In the first section, the importance of good corporate governance is established. Section two describes the relationship between good corporate governance and board diversity and elaborates on the independence of board members. The third section identifies the variables of board diversity that are important for good corporate governance, describing each of the diversity variables (age, gender, educational background & expertise, nationality & ethnicity, and insider/outsider ratios), their relevance to the topic and the state of the art of the existing literature. In the fourth section, the differences in board structure between a one-tier and a two-tier board structure will be explained. Finally, the fifth section gives a short summary, establishes the relationships between the researched variables and reflects on the gaps in the current literature.

3.1. The importance of good corporate governance

Before we can delve deeper into the relation between board composition and corporate governance, the preliminary questions arise what exactly corporate governance is and why it is important. There is no single accepted definition of corporate governance and the definitions differ according to the countries in which they are formulated (Solomon, 2010). According to Shleifer and Vishny (1997), for example, corporate governance deals with the way in which investors in a firm assure themselves of getting back their investment. The OECD (2004) on the other hand describes corporate governance as a set of relationships between a company’s management, its board, its shareholders and other stakeholders. Corporate governance also provides the structure through which the objectives of the company are set, and the means of attaining those objectives and monitoring performance are determined.’ As one can see, the first view is a quite narrow view, exclusively focusing on the relationship between shareholder and manager, whilst the second view is broader and also encompasses the importance of stakeholders. In the Netherlands, the Commissie Corporate Governance (2003) applies a more broad view of corporate governance, stating that a company is a long-term method of cooperation between multiple parties that are directly or indirectly involved in or having influence on achieving certain objectives of the company. The company strives to create shareholder-value in the long run, but also needs to balance the interests of all other parties involved. Since this research focuses on corporate governance in the Netherlands, the view of the Commissie Corporate Governance will provide the framework in which to place corporate governance practices. Thus good corporate governance in this research means creating shareholder-value in the long run, whilst preserving the interests of the other parties that hold a stake in the company.

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investment. Results from the McKinsey Global Investor Opinion Survey (2000) indeed showed that investors were willing to pay a premium for firms which they believed to be well-governed, leading to a lower cost of capital for firms. Thus if firms want to reap the full benefits of this internationalization of capital markets, they must develop a credible corporate governance system, which must be transparent and understandable across borders. However, corporate governance is not only relevant because of the increase in financing opportunities. Especially in the field of strategic management, the stakeholder view of corporate governance has received attention. As Barnard already stated in 1962 the firm is a cooperative organization based on rational principles. Freeman (1984) added to this by arguing that the central challenge of strategic management is to create a satisfactory balance of interests amongst the diverse constituencies that can affect the firm. The notion of balancing different interests so that the firm may continue operating properly thus is not a new viewpoint and has received much debate since. In a special edition of the Strategic Management Journal (1997), the conclusion was reached that the successful performance of a firm is determined by a combination of access to resources and its position within its industry structure, which are reciprocally interacting with each other. Hence, good corporate governance not only increases the access to resources because it gives the firm the opportunity to reap the benefits of the internationalization of capital markets, but also provides guidelines for developing a sound strategic plan that helps position the firm within its industry structure. Combined, these two factors form the key to good performance of a firm.

3.2. Good corporate governance, board diversity and independence

As seen in the previous section, good corporate governance forms the key to a good performance of the firm. Then what is the role of the board of directors within good corporate governance? And what influence does board diversity have on corporate governance?

The board of directors plays an important role in an organization as it functions as an internal control mechanism and in this way deals with certain issues of corporate governance (Kent, Baker and Powell, 2009). Zahra and Pearce (1989, 1992) have identified three different roles the board of directors fulfills, namely service, strategy and control. In their view the service role aims at the representation of the firm to the outside world, protection of the firm’s interests in the community and connecting the firm with the outside environment. The strategy role then encompasses defining and implementing a business strategy for the firm. The control role then entails the alignment of senior management and executives with the interests of the shareholders. Although Zahra and Pearce describe the role of the board in the light of the interests of shareholders, much stays the same when taking into account the stakeholder perspective. More specifically, according to the Dutch Corporate Governance Code the board of directors is responsible for the management of the firm, which entails the business strategy, the balancing of interests of different stakeholders and the relationship with parties outside the firm.

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mixed. Dalton, Daily and Ellstrand (1998), for example, performed a meta-analysis on existing research investigating the relationship between board composition and firm financial performance and concluded that a certain type of board composition did not necessarily lead to a better financial performance of the firm. Although research on board composition thus found that is does not necessarily lead to better financial firm performance, there are indications that board diversity still can have a positive effect on overall firm or organizational performance. According to Van der Walt and Ingley (2003) “the concept of diversity relates to board composition and the varied combination of attributes, characteristics and expertise contributed by individual board members in relation to board process and decision making.” Erhardt et al (2003), for example, discovered that board of directors' diversity does lead to better firm performance and that it can help decrease agency problems. Furthermore, Kang et al (2007) found that a more diversified board increases discussion, the exchange of new ideas and group performance and thus provides the board with new insights and perspectives. Continuing, a more diversified board of directors will be better able to adapt to the different expectations of different groups of stakeholders (Huse and Rindova, 2001). Also, more diversification decreases cohesion and thus the risk of groupthink and a focus on one option, enhancing the exploration and balancing of multiple alternatives (Janis, 1982). The risk of groupthink can be decreased by increasing the diversity of board members, as it decreases pressures towards uniformity and closed-mindedness (Janis, 1982; Van Zijl, 2012). Especially in situations where close monitoring is required and where the contact between executive and supervisory board members is high, the risk of groupthink should be decreased as much as possible as groupthink is believed to decrease the decision-making quality.

Thus, diversity within the board of directors serves multiple purposes. However, having a diversified board by itself is not sufficient. Even when board members have different background and characteristics, they need to be able to operate and think independent of each other. As said above, diversification decreases the risk of groupthink, but in order to improve the quality of decision-making, a certain degree of independence of board members is equally important.

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best way possible, which is not necessarily in the best interests of the shareholder. Independent supervising board members consequently are necessary to monitor the behavior of the board member, in order to align the interests of the principal and the agent (the shareholders and board members) and protect the shareholder from non-beneficiary decisions of the agent and to decrease the costs associated with the principal-agent relationship.

Independence is also an important characteristic of board composition in the more stakeholder oriented view of The Netherlands. Here, supervision by independent board members is necessary in order to monitor the taking into account of all stakeholders’ interest. The Dutch Corporate Governance Code underlines this in principle III.2, stating that the supervisors must be able to act critically and independently of one another, the management board and any particular interests.

Thus, no matter which economic theory is adopted, a high level of diversity and the improved independence of supervisory / non-executive directors that results from it, is beneficial. This is the case whether the goal of the company is profit-maximization for shareholders (independence in relation to the executive directors) or protection of stakeholders (independence in relation to the shareholders and the executive directors).

Van Zijl (2012) furthermore conducted a literature review on the relationship between independence and performance, analyzing 48 existing studies on this topic. He however did not find a consensus in the existing literature. Some research results showed a positive relationship, others showed a negative relationship and again other studies reported mixed results. Van Zijl thus concluded that there is no proof of an undisputed relationship between independence and performance. Yet, the mixed results can to a certain degree be explained by issues such as the methodology, definitions and time spans between the concerned researches. Also, the analyzed research chose financial results as the researched outcome of board independence, whilst financial results is only a part of the total benefits good corporate governance may offer and, especially in a more stakeholder oriented view, not necessarily the most important benefit.

When summarizing the existing research on the influence of independence one thus cannot conclude that there is a definite relationship between independence and firm financial performance, but independence is believed to have positive effects on corporate performance. Furthermore, director-specific characteristics such as available time and previous expertise play an important role, and hence should be taken into account. A more diverse board should lead to a more independent board, where a more independently functioning board is believed to improve the quality of decision-making and will be conducive for achieving the goals of the company, be it profit maximization for shareholders or protection of stakeholder’ interests.

3.3. Identifying elements in board composition relevant for good corporate governance

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the board of directors fulfills an essential role. Furthermore, according to Zahra and Pearce (1989) board functioning is highly related to organizational performance. Since the board of directors can have such an influence on the credibility of the corporate governance system of the firm, close attention should be paid to the way in which the board is comprised. Certain issues with regard to board composition such as board independence (Bhagat and Black, 2002 & Hermalin and Weisbach, 2003) and the division of CEO and chairman positions amongst different individuals (Brickley, Coles and Jarrel, 1997) have therefore received a lot of attention in both academic and business press. With regard to the independence of the board, empirical evidence exists that a board with more outside directors decreases the likelihood of financial state fraud (Beasley, 1996), increases shareholders wealth in cases of management buy outs (Lee et al. 1992) and leads to higher turnover rates for poorly performing CEO’s (Weisbach, 1988). Thus, many researchers underline the importance of paying attention to board composition.

Board diversity as an element of board composition is another topic that has drawn the attention of researchers. Traditionally however, research on board diversity was characterized by a distinction between two lines of research, namely between observable diversity and non-observable diversity. The non-observable characteristics of diversity generally include age, gender and ethnicity whilst non-observable characteristics include subjects such as knowledge, education and perception (Erhardt et al, 2003). In this research the observable and non-observable characteristics of diversity in the composition of board members will be combined. The elements of board diversity to be researched in the following sections hence are age, gender, nationality and ethnicity, educational background and expertise and finally insider/outsider ratio.

3.3.1. Diversity in the age of board members

The first variable of board diversity that will be researched is the variable age. Age diversity is one of the most important observable background diversity issues and thus generates attention (Kang, Cheng and Gray, 2007). This attention mainly stems from the fact that age is a highly visible characteristic that can be used for social categorization and consequently forms a potential danger of stereotyping and polarization (Timmerman, 2000).

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been found to have more favorable attitudes toward risk-taking.' Age diversity furthermore gives the firm the opportunity to employ different aspects of human resources, whereby the older people may bring in experience and wisdom, the middle-aged group carries the majority of responsibility and the younger people bring in energy, plan ahead for the future and intercept succession issues (Kang, Chen and Gray, 2007). Huse and Rindova (2001) argue that differentiation in age can especially be relevant in aligning the products and services of a company with the different age groups it wants to target.

When diversifying in the age of the board members, a firm can thus reap the benefits of both the more conservative style of the older board members, whilst at the same time taking advantage of the more up-to-date knowledge, enthusiasm and energy of younger board members.

3.3.2. Diversity in the gender of board members

The second variable to be researched is the gender of member of the board. Gender diversity is a topic that has generated increasing attention in public debate, academic research, corporate governance codes and corporate strategy (Dang & Vo, 2012). This section explains the concept of gender diversity and discusses its relevance.

Gender diversity indicates the proportion of male and female members on a specific board. Firms should pay attention to gender diversity because of a variety of reasons. First of all, gender diversity is an important topic simply because investors pay attention to it (Francoeur, Labelle, Sinclair-Desgagne, 2008). This also shows in the fact that female employment is included in the criteria of social investment indices such as the Domini 400. Secondly, legislation and corporate governance best practice initiatives prompt firms to improve their gender diversity. Countries such as Norway and Spain have set quotas for women in boards of directors and other countries are considering comparable initiatives (Terjesen, Sealy and Singh, 2009). Furthermore, the Sarbanes-Oxley Act in the United States and the Higgs review in the United Kingdom explicitly stress the importance of board diversity (Adams and Ferreira, 2009). The Dutch Corporate Governance Code states in principle III.3 that diversity of (amongst others) gender should be taken into account when appointing supervisory board members and the "Wet Bestuur en Toezicht" states that at least 30% of the seats of the board of directors (both in executive and non-executive functions) in a company should be filled by women. A third reason why firms should be considerate towards gender diversity is because it allows them to access the widest possible pool of talent, especially since women nowadays account for the larger part of graduates both in the United States and Europe (Francoeur, Labelle, Sinclair-Desgagne, 2008). Also, the pool of suitable male candidates for board positions is decreasing (Van der Walt and Ingley, 2003), even more so now that the numbers of supervisory board positions has been limited to five functions, whereby a chairmanship counts as two positions.

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general, women do tend to be more participative, democratic and communal than men, leading to better boardroom behavior (Bear, Rahman and Post, 2010). Also, women usually are more risk-averse and have another cognitive bias than men (Dang & Vo, 2012). A second benefit for the firm is the positive influence of female board members on overall attendance (Adams and Ferrera, 2009). Furthermore, Adams and Ferrera (2009) discovered that women tend to focus on monitoring tasks, which could help improve corporate governance in firms. Burgess and Tharenou (2002) continue with their summarization by stating that women contribute an independent view and can change the strategic direction of a company. In addition, women in board positions tend to be associated with long term company success and competitive advantage. Women in board positions can function as role model or mentor for other women. A final argument in favor of women as board members is that women are essential for most firms, since they purchase 81 percent of all products and services and control some 80 percent of household spending in the United States (Heffernan, 2002), and who else is better in understanding what female customers want than other women?

Although there are strong arguments for gender diversity within the board, the facts do not (yet) underwrite this. According to Dang and Vo (2012) ‘women’s progress in gaining seats on boards of directors worldwide is glacially slow’. Then what are the reasons why firms have not yet implemented gender diversity? According to Fitzsimmons (2012), research on this topic usually describes the same barriers. First of all, board members tend to look for new board members that are similar to them, thus when a board has a majority of male members, they tend to choose another male member. This so-called similarity bias is somewhat decreasing, but this does not seem to result in more board positions for women. Secondly, women lack access to the so-called ‘old boys’ network’ and other types of informal networking that are essential to gaining a place on corporate boards. Thirdly, women experience the so-called ‘pipeline problem’ indicating that board members are usually recruited from the same small pool of candidates that are already working at the highest organizational level, thus excluding women that have extensive experience, but not at exactly the right position. Finally, Fitzsimmons (2012) points to the lack of female role-models and mentors, and a lack of commitment within top management to appoint women who could fulfill such a position.

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19 3.3.3. Diversity in nationality and ethnicity of board members

This section deals with diversity in nationality and ethnicity of board members. Together with age and gender diversity, this is a ready-detectible, relations-oriented characteristic (Jackson, Joshi and Erhardt, 2003). Although nationality and ethnicity are of course different variables, they are treated next to each other in this section. Both ethnicity and nationality can be indicators of a different cultural background and thus can be an indication of diversity amongst board members. This section first describes diversity in the nationality of board members and then continues with the ethnicity of board members.

Nationality is a strong indicator for a relationship between an individual and its country of origin (whether by birth or by naturalization). Already in 1969, Perlmutter suggested that diversity in nationality within companies would be increasing over time, which would also extend to the executive and supervisory level. He believed that due to the globalization, companies would tend to become geocentric instead of ethnocentric, which would require a shift in focus of top management. Nationality diversity can thus be seen as an indicator of the level of internationalization of a company. Furthermore, Bartlett and Goshal (1998) state that nationality diversity can be an indicator of a transnational mindset, which, according to Tan and Mahoney (2006) is beneficial since this increases knowledge of foreign markets and could thus improve firm performance. Also, as described in previous sections, the pool for recruiting supervisory board members needs to be increased, which can be done by including candidates with different nationalities than that of the country of origin of the firm itself. Ethnicity, although it may encompass nationality, relates to factors such as language, religious belief and culture, but may also relate to racial differences. In board diversity research, the focus has been on the inclusion of racial minorities as representation of ethnic diversity within the board of directors. Traditionally, those racial minorities have been underrepresented in boards. Yet, racial minorities representation on the board of directors is indeed increasing, however slowly it may be. Racial and cultural diversity, just as nationality diversity, is critical in understanding the wishes of a culturally diverse customer base. Furthermore, it can help shape the strategic context of a firm in an increasingly diverse market context (Miller and Triana, 2009). Apart from this, minorities tend to have more diversified social networks which can be helpful for receiving information that can be used in decision-making processes (Ibarra, 1993). Next to the benefits for the quality of governance within the firm itself, the inclusion of racial minorities can also have a signaling function towards the public. A racially diverse board signals that the firm is well-positioned to meet the demands of the market, giving the idea that it understands the business environment and can thus give sound advice towards the executives. Continuing, it signals the firm’s dedication towards creating social value which gives the firm legitimacy and in turn has a positive influence on the reputation of the firm (Miller and Triana, 2009).

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20 3.3.4. Diversity in educational background and expertise of board members

Educational background and expertise of board members are typical examples of non-observable or cognitive diversity (Milliken and Martins, 1996). Each board members brings a unique set of resources to the firm, consisting of expertise, skill, knowledge and networks to other firms (Hillman et al, 2002). This unique set of resources is, next to the demographic variables describes in the previous paragraphs, highly shaped by the educational background and previous experiences of the board members.

Firms tend to become more and more specialized and are often relying on technological advantages. This increase in specialization leads to an increased importance of human capital (Rose, 2007). Human capital can be seen as a combination of both experience-based capital, referring to the experience and tenure track of an individual, and educational capital, referring to the education an individual has received. The human capital of individual board members shapes their advisory and supervisory qualities (Kor and Sundaramurthy, 2009).

The past and current professional occupation shape the thinking and frame of reference of a board member (Kor and Sundaramurthy, 2009). In order to be an effective board member, an individual must be able to make complex decisions and must be able to review multiple and differing streams of information. Therefore it is beneficial when a board member already has previous experience with the fulfillment of a board position. This is underlined by the research of Chan and Li (2008), who discovered that more expert board members, being those who had experience with executive tasks in the past, had a positive influence on performance. It is however not necessary that every individual has experience with executive tasks, since eventually, it is the collective action of the board members that is decisive (Kor and Sundaramurthy, 2009). In order to gain from experiences of board members, it hence is beneficial to also include individuals that have gained experience in other industries.

When it comes to educational background, the only really essential element seems to be that the board member has received a university degree or has equivalent skills, where is does not matter which specific educational background has been followed (Rose, 2009). Yet, different perspectives are necessary in order to prevent groupthink and a wide variety of ideas and knowledge is beneficial to problem recognition and analysis (Kor and Sundaramurthy, 2009). Thus diversity in the specific educational background can indeed be beneficial to the firm.

3.3.5. Insider/Outsider ratio

The final diversity variable is the insider/outsider ratio. This ratio describes the proportion of board members that come from within the firm compared to board members that are attracted from outside the company.

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constitute a board of directors with a majority of outside directors in order to increase independence, since it is believed that this makes a positive contribution to the monitoring tasks of the board of directors. The view that outsider board members can contribute to more than just a better financial performance, is supported by Ibrahim, Howard and Angelidis (2003). They found that in service companies, outside board members are more sensitive to the needs of society and are more likely to oppose a financial results oriented view of organizational performance. Furthermore, Johnson and Greening (1999) state that outside directors may feel freer to advocate costly or unpopular decisions, especially involving compliance issues. Furthermore, Fich and Shivdasani (2006) found that outside-dominated boards are more likely to remove CEOs for poor performance than inside-dominated boards, as long as the independent board members had enough time to perform their respective functions. This is in alignment with the provisions in the Dutch Corporate Governance Code limiting the amount of board memberships one individual may fulfill, thereby prohibiting the accumulation of supervisory positions of certain board members that has been common practice in the past.

Thus, a healthy insider/outsider ratio is believed to lead to a more independent and better functioning supervision mechanism which in turn should improve the corporate governance of the firm.

3.4. Structure of the firm: differences between the one-tier and the two-tier board

This section elaborates on the differences between the one-tier and two-tier board structure as can be observed within the Dutch law and practice. First the currently most commonly used system of the two-tier board structure will be described, covering the main elements that are typical for this regime. Then the one-tier board structure will be described, highlighting the differences with regard to the two-tier board structure. Finally, the strengths and weaknesses of both systems will be described.

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insofar this is necessary to decide on the approval of a certain decision (Calkoen, 2011). A third important element is the representation in case of conflicting interests. When one or more executive board members have a so-called conflict of interests, art 2:146/1256 DCC states that the supervisory board has to function as the competent organ in the decision-making.

The one-tier board on the other hand has a single or monistic board where part of the board members have an executive role, whilst the other part of the members monitors the executive board members. The most important difference between the one-tier and two-tier board structure however lays in the responsibility and liability of the non-executive or supervisory board member (Timmerman, 2009). In the one-tier board structure, there is no judicial difference between the executive and non-executive director. This means that in principle they are both joint and severally liable in cases of bad governance of the firm. Another consequence is that the executive and non-executive directors are both actively involved in the decision-making process, including strategy and succession planning, hence non-executive directors carry a greater responsibility (Calkoen, 2011). However, also in the one-tier board system, certain tasks are explicitly reserved for the non-executive director, such as the monitoring of the executive directors, decisions on the remuneration of the executive directors, the appointment of a chairman and the proposal of new board members. (Nienoord, 2012). With regard to these topics, the supervisory board member and the non-executive director both have the exclusive rights.

Advocates of the one-tier board system argue that the decision-making process can be speeded up and mutual consultation is more easily possible. Furthermore they believe that the non-executive director will have better access to relevant information and the larger responsibility forces him to more actively pursue its monitoring role (Timmerman, 2009). An important concern is however that the non-executive director in a one-tier board structure may have difficulties attaining the degree of independence that is necessary for the monitoring of the executive directors, which is essential for a balanced decision-making process. Also, because the non-executive director has to fulfill a more active role in this decision-making process and has a greater liability than its counterpart in the supervisory board, the non-executive director must fulfill higher quality requirements. Not only does he have to be independent and able to monitor the processes, but he also needs to have more in-depth knowledge and administrative capabilities. The question arises whether there are enough individuals to fulfill these positions, especially since the United Kingdom already seems to have a lack of qualified experts that can fulfill non-executive directorships (Vletter-van Dort, 2009).

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23 3.5. The relationship between board structure, board diversity and corporate governance

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24 4. An analysis of the composition of the board in Dutch firms

In this chapter an analysis is made of the composition of the board in Dutch firms in recent past years, using already existing data, namely the reports of the Insituut voor Ondernemingsrecht and the SpencerStuart Board index. SpencerStuart publishes a yearly index of board characteristics for the top 50 firms listed on the Dutch stock exchange, whilst the Instituut voor Ondernemingsrecht (hereafter: ‘IvO’) focuses on a sample of listed firms (AEX, AMX and AScX) and non-listed local firms and only includes numbers on leaving, newly appointed or reappointed supervisory board members, thereby more focusing on trend lines.

Since the two-tier board structure is still the most-used board structure in The Netherlands (the SpencerStuart index contains only six companies with a one-tier board structure), both the SpencerStuart and IvO reports do not make distinctions between firms with a one-tier or a two-tier board structure. This section depicts the composition of non-executive board membership in Dutch firms, described for each of the elements that have been distinguished in chapter 3 and for both the one-tier and two-tier board structure.

4.1. Age diversity

According to SpencerStuart the average age of non-executive board members was 62.2 years in 2011. The IvO only researched the age of newly appointed non-executive board members in 2011, which is an average of 56 years. The non-executive board members that have left in this year were on average 64 years old. Furthermore, IvO found that compared to their earlier researches, the general age of non-executive members was dropping, although this fluctuated heavily between the different categories of firms. Yet, although the average age was dropping, most of the newly appointed non-executive directors were still to be found in the age group 61-65 years and could thus still be said to be relatively old. However, SpencerStuart discovered that the age of female non-executive board members was on average 52 years old, whilst the average age of the male members was 63.7, thereby indicating that women are generally on a younger age active as non-executive board members than men.

4.2. Gender diversity

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25 4.3. Diversity in nationality and ethnicity

59.9% of all non-executive positions of the top 50 Dutch firms are held by Dutch nationals. Of the 40.1% of non-executive board members with a different nationality, 10.4% of the positions is held by nationals of the United States, followed by 7.4% from the United Kingdom and 7.1% from France (some of the researched firms are bi-national, all non-Dutch board members here are treated as being foreign directors). AEX firms have a significantly higher proportion of foreign nationalities than AMX companies (SpencerStuart board index 2012). The IvO report shows that the ratios foreign and national directors are relatively stable and have not changed much recently. Both reports do not give information about the ethnicity of the non-executive board members.

4.4. Diversity in educational background and expertise

The SpencerStuart report does not pay attention to the educational background and expertise of the non-executive board members. The IvO report on the other hand researched the both education and the field of expertise of those supervisory board members that left, were appointed or were reappointed in 2011. First of all, they discovered that still most supervisory board members possess an academic degree, although this level is slowly dropping. Furthermore, 76% of the supervisory board members have received an education in one of the five major fields of education (namely business economics, technical degrees, MBA, general economics or law), whereas business economics is the largest contributor and is closely followed by law. In earlier years, the total percentage of supervisory board members from one of the five major fields of education was lower, for example 69% in 2010, thus decreasing the general diversity in educational background. However, the IvO does not make distinctions within the fields of education and thus it is difficult to establish how diverse the educational background from board members within those fields is. When we look at the expertise of the supervisory board members, the IvO discovers no great variation compared to previous years. Forty-five percent of the supervisory board members have gained expertise in trade and industry, thereby making it the most common background. Other fields of expertise that are significantly represented are corporate finance & accountancy, banks and insurance companies and finally investments. Finally, the IvO report has researched the background of the supervisory members in 2011. Here also trade and industry makes up the largest proportion of the group with a grand total of 87% of all supervisory board members appointed or reappointed in that year, thereby marginalizing the other background groups.

4.5. Insider/outsider ratio

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dependent non-executive director is considered to be non-independent. The Ivo found that 20% of the in that year appointed non-executive directors were non-independent, which was a slight increase from the 15% in 2010. Most of the non-independent non-executive directors were considered not to be independent because there was a relationship with the major shareholder (70% of all dependent executive directors). The increase in dependent non-executive directors is mainly caused by the local firms that are researched by the IvO, the researched AMX firms only had 7% dependent non-executive directors appointed, followed by 14% dependent non-executive directors in AEX firms.

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27 5. Interviews

The entering into force of the ‘Wet Bestuur en Toezicht’ provides a good opportunity to investigate whether adoption of a one-tier board structure indeed leads to more diversification in the board of directors and, following, better corporate governance. Because the elapsed time between the implementation of the law and the conduction of this research has been too short to provide a reliable set of quantitative data, information about the possible effects can better be obtained by ways of interviewing experts in the field of corporate governance. Furthermore, interviews are a suitable method for obtaining data in an exploratory research, as the experience and opinions of the interviewees can be researched in the broadest and most exhaustive way, where they provide relevant information for answering the research question and ensuring nothing that is important in their opinion is left out. This section first starts with a short description of the interview and details the questions that formed the guideline for the interviews. Following, the interviews themselves are reported on an individual basis.

5.1. Preparing the interviews

The interviews have been conducted personally between the researcher and the interviewed person. The purpose of the research is exploratory regarding the influence of the one-tier board structure on board diversity in the Netherlands, yet at the same time the most important variables establishing diversity have already been identified. Therefore, the conducted interviews are semi-structured interviews, ensuring that the research questions are answered as good as possible whilst also providing for opportunities to explore the research topic in more depth. At the start of the interview, the interviewee was presented with information regarding the researcher and the theme of the research. Following, three open-ended questions about the research topic were asked, namely:

- Which elements of board composition (or board diversity) do you consider as relevant

for good corporate governance?

This question tries to establish whether the elements of board composition that have been identified in the literature section, are indeed identified as being important elements in the eyes of the interviewed persons. By answering this question, the interviewees give their opinion on the research sub-question regarding the relevant elements of diversity regarding board composition.

- Do you believe that the entering into force of the ‘Wet Bestuur en Toezicht’ will lead

to more companies that will implement a one-tier board structure?

By answering this question, the interviewed person provides his/her opinion on the possible changes in board structure due to the entering into force of the ‘Wet Bestuur en Toezicht’. This also relates to the research sub-question about the influence of the one-tier board structure.

- Do you think that a one-tier board structure will lead to more diversity in the

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When answering this question, the interviewee was asked to identify whether the one-tier board structure is in their eyes indeed capable of improving diversity amongst the non-executive directors. This question is related to the research sub-question asking whether a one-tier board structure leads to more diversity in the relevant elements of board diversity. Next to the questions that were asked in all interviews, questions were asked for clarification or to gain a more in-depth answer, thereby ensuring the research question and sub questions were answered as extensively as possible. Those questions varied from interview to interview. After the interviews were conducted and processed, all interviewees received a transcript of the interviews. All transcripts of the interviews have been read and approved by the interviewees.

5.2. Interview with Huub Willems

Prof. mr. Huub Willems is (amongst others) professor in corporate litigation at the Rijksuniversiteit Groningen and was chairman of the Enterprise Court, forming part of the Court of Appeal (in Dutch: Ondernemingskamer). The Enterprise Court has exclusive jurisdiction in certain corporate proceedings, the most important being the inquiry proceedings in which the Enterprise Court can be asked to investigate the affairs of the company. In that capacity, Mr. Willems has had extensive experience with non-executive board members.

First of all, Mr. Willems notes that diversity is a necessary condition for quality. The biggest danger a company can face is to have non-executive board members that lack critical powers. Non-executive board members must be able to contradict the executive board and must be able to ask those questions other people are not able or willing to ask. In the past, he has seen many cases of dysfunctional supervisors. He sees the same people returning as supervisory board member over and over, whilst they are not necessarily experienced or capable enough to fulfil the function, which in his eyes is incomprehensible. Therefore he contemplates that the main problem with diversity is that firms are seemingly not capable of attracting and selecting capable board members.

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Furthermore, older people are less inclined to see the supervisory position as another step in their career. Yet, one has to watch out for those older persons who are nostalgic and are mainly complaining.

Diversity in gender is important, but Mr. Willems believes this should be a consequence of selecting people based on their qualities and thus does not think a quota poses a solution. He does notice that certain firms still appear to have an attitude against female board members. When considering nationality and ethnicity however, there seems to be another problem. There are enough capable persons within ethnic or national minorities, yet they seem to be less interested in supervisory positions. Yet different cultures within a board can have positive influences, as it gives you the opportunity to cherry-pick the best norms and values from multiple cultures.

Mr. Willems thinks the one-tier board structure actually does not influence the level of diversity. Diversity should be realized because the firm sees the additional value of it and wants to do it. If a firm does not (wishes to) see the additional value of diversity, the structure of the board will not change this. In his opinion, the main benefit of the one-tier board structure is that foreign firms can come to the Netherlands whilst using their already existing structure. Thus it is not a solution to diversity issues.

In the eyes of Mr. Willems, diversity should automatically improve if firms are motivated to select people on quality and are indeed capable of doing so. Selecting the best persons is a process that requires time and effort, and this is a change in culture not all firms have yet been willing to make.

5.3. Interview with interviewee X

Interviewee X currently has his own company, but in the past has worked in banking sector in both London and Amsterdam for several international banks.

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especially when a firm is active in multiple countries, diversity in nationality can provide benefits to the firm.

Interviewee X perceives that, in his opinion, the two-tiered board structure as it is applied in the Netherlands is not functioning very well. He observes a lack of knowledge, skills and critical ability under current supervisory board members, where the focus is too much on combining multiple supervisory positions and a earning some compensation and too little on the real supervisory tasks. As from the firm perspective, the focus seems to be on the network an individual can bring along and the firm can make use of.

Interviewee X furthermore believes that the tasks of supervisory board members under the two-tier board structure are not defined enough. The assignment usually is fuzzy, not providing directions as to where to look at and he thinks that many people that would indeed be very well qualified to fulfill a supervisory position, choose not to do so because of this. He believes that the one-tier board structure here could provide a solution. People that are well-qualified for such a position will, in his opinion, choose a one-tier board structure over a two-tier board structure because this will enable them to gain better knowledge and information about the firm, which enables them to fulfil their position better. Also, because a one-tier board structure provides a higher liability risk, people will more consciously decide to take up such a position, which attracts a different kind of people from those that are now mainly dominating the supervisory positions. Finally, because the one-tier non-executive directorship takes up more time than a two-tier supervisory function, he believes that people will be able to do their job better. Real and effective supervision is not achieved by meeting only a few times a year for discussion.

To conclude, interviewee X states that it depends on the situation which kind of diversity is necessary and that diversity in itself is not a guarantee for good supervision.

5.4. Interview with Max van der Sleen

Max van der Sleen is director of Ethical Growth Strategies BV. Until 2012 he was worldwide CEO of Ecorys, an economic advisory agency with offices in 10 countries that focuses on economic, social and spatial development. In this capacity he has worked with both the one-tier and two-one-tier board structure.

Mr. Van der Sleen is convinced that diversity improves quality. Diversity adds an extra dimension to the process, through which people will watch each other more closely and thus function better. This is especially important in fulfilling the advisory role of supervisory board members.

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believes it would be good to include a younger generation in supervisory positions. As with regard to diversity in background, he observes a growing diversity.

Mr. Van der Sleen observes that in the one-tier boards he has experience with, diversity was not better than in the two-tier boards he has worked with, those one-tier boards for example did not include female board members. The two-tier boards on the other hand, always had female board members. He does believe this could be influenced by a certain degree of positive discrimination. Ecorys is a socially responsible firm and therefore diversity is more important to them than it is within commercial firms. Mr. Van der Sleen has the idea that commercial firms have a stronger focus on the commercial background and networking capabilities of the board members. Yet networking capabilities are not necessary for the correct fulfillment of supervisory positions. This is slowly beginning to change due to the need for transparency and openness, but he believes that it will take time before commercial firms will adapt to this.

Mr. Van der Sleen remarks that the one-tier board structure implies more personal responsibility. The duties of the supervisory position changes and more focus is put on the advisory role and the development of a strategy for the future of the firm. Especially in this advisory role, diversity is more important. A diverse team is better capable of observing the future possibilities. Mr. Van der Sleen thus believes that the one-tier board will attract different people than a two-tier board, as it comes with other responsibilities and challenges, and should also come with a different remuneration profile.

5.5. Interview with Nick van Ommen

Nick van Ommen holds multiple supervisory board memberships in Belgium (Vastned Retail, Intervest Offices & Warehouses), Austria (Immofinanz), Greece (Babis Vovos) and the Netherlands (Allianz Asset Management) and a non-executive directorship in the board of W.P Carey in the United States. In the past he has worked for multiple banks and was the founder and director of the European Public Real Estate Association (EPRA).

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and gender of the new board member. Especially the male/female ratio is still a topic where Mr. Van Ommen observes problems. He himself believes there are more than enough capable women to fill positions in supervisory boards, but has experienced that other male supervisory board members sometimes are reluctant to admit this. He furthermore believes that the other variables mentioned in this research are important. He notices that in the Netherlands as of yet there is still insufficient diversity, but expects that change will arise here as well.

Mr. Van Ommen believes that the supervisory board members in a one-tier or a two-tier board structure actually should be doing the same, namely supervising and advising the executive board. The fact that in the one-tier board structure the supervisory members are positioned closer to the executive board should not really make a difference. The one-tier board on the other hand does lead to a higher amount of personal exposure for the supervisory members, but when one is afraid of taking risks, one should not accept a supervisory position at all. Mr. Van Ommen believes that a positive and constructive critical view is necessary in both structures. Many people still have problems with that attitude, and therefore lack critical capabilities.

Mr. Van Ommen thinks the board structure does not really influence the degree of diversity within supervisory boards. He does believe that due to the greater personal exposure in the one-tier board, people will be more reluctant to take up a supervisory position there. On the other hand, this will hopefully lead to a higher level of quality of supervision, as the supervisory members will carefully need to consider whether they indeed have the background, expertise and skills necessary for fulfilling their position.

Mr. Van Ommen considers that there has been a lot of discussion on whether the one-tier or two-tier board structure leads to more effective supervision, but has never really seen evidence that one type of board structure is better than the other. In his view, the role the supervisory board members must fulfil is more important. Supervisory board members should have a positive critical attitude towards the interests of all stakeholders. Here, diversity could have a positive influence on the capability of the supervisory board to fulfill its role.

5.6. Interview with Bart Bierman

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emphasis on diversity within her behavioral culture research and uses so-called suitability matrixes to address the capacity and competences of the collective supervisory board members of a bank or financial institution. These suitability matrixes should lead to supervisory boards with more complementary members, which could then in turn lead to more diversity. So far however, it seems that the selection of supervisory board members is more regulatory than intrinsically motivated in the banking and financial institutions sector. As with regard to diversity, future European legislation regarding capital requirements for banks and financial institutions also contains a paragraph on this topic and it is expected that the European Banking Authority will issue guidelines containing certain quota that should be adhered to. Therefore Mr. Bierman expects there will be more attention for diversity in the future. On the other hand he observes that it is difficult for banks and financial institutions to find both diverse and suitable supervisory board members. Mr Bierman however is of the opinion that, even though this can be hard, banks and financial institutions should at least try to select both diverse and suitable supervisory board members. Especially with regard to the current restrictions on the number of supervisory positions, the question rises whether it is possible to find enough suitable candidates. Therefore Mr. Bierman expects that the emphasis will be on suitability, and diversity will be considered less important, which is regrettable. Mr Bierman says that up until now, Dutch banks and financial institutions rarely use a one-tier board structure. Some banks and financial institutions however have shown interest in the possibility of the one-tier board structure, but real proposals have yet not been introduced. In principle, Mr. Bierman believes stakeholders and employees should be able to guard the quality of the undertaking as well.

Concluding, Mr. Bierman notes that diversity in the banking sector is a difficult topic. On the one hand, diversity is important with regard to innovative capacity and it is good to hear multiple views on a topic before making a decision, but on the other hand knowledge and expertise is also of utmost importance. Thus banks and financial institutions sometimes have to make a choice between the two, and he believes that the focus then (encouraged by DNB) will be on expertise before diversity.

5.7. Interview with Hans van Grieken

Hans van Grieken is (amongst others) Vice President Business Innovation at Capgemini, Adjunct Professor at TriamNimbas and Executive Lecturer at Nyenrode University. At both universities he teaches on the topic of innovation. He is also a member of the supervisory board of Priva, a family business and world market leader in the field of automation and climate control of greenhouses.

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