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contribution to the strategic decision-making.”²⁶

      Board Chair

To facilitate better strategic governance, we examine the relationship between the board chair and the chief executive officer. As mentioned, the audit culture prompted by agency theory²⁷ creates a relationship between a CEO and a control-oriented chair marked by distance and authority. This relationship does not always need to be solely control-oriented and can have a collaborative approach in which the board chair provides strategic advice. For example, when Hewlett-Packard split into two companies, Meg Whitman became CEO of Hewlett-Packard, Inc., and at the same time board chair of Hewlett-Packard Enterprise. She said in a CNBC interview: “I know the role of the chairman, and I know how it is different than the role of the CEO. The chairman is not there to run the company. The chairman [role] is to help the board be productive, help the CEO be successful.” As Whitman suggests, the chairman may play a supportive role to the CEO, providing a close source of advice and guidance.²⁸ Also, separating the CEO and chair roles (as opposed to cases in which the CEO is also the chair), as Whitman did, may enhance CEO–board collaboration by reducing the demands on the chief executive's time, allowing the CEO to specialize in managing the firm's strategy and operations.

Although many firms still assign the chairman position to the CEO to provide a unitary authority structure,²⁹ some scholars under the agency theory advocate for separate roles to provide better control of management.³⁰ Having the positions as separate roles with a collaborative board chair can provide both improved strategy and better board leadership. Research supports this conclusion, finding that board chairs can provide significant value (up to 9 percent improved firm performance) through advice and counsel, legitimacy, information linkages, and preferential access to external commitments and support.³¹ This approach proves particularly beneficial when firms face fast-changing external environments such as in high technology firms. In essence, by providing improved strategic governance, board chairs can add significantly to firm value.

      Board Committees

Board members who chair key board committees can also add to firm value through their approach to strategic governance.³² In fact, the importance of board committees has grown over time due to increased legal requirements and the growing complexity of the business environment.³³ Research tells us about the overall board structure or board member demographics, such as functional backgrounds and ages, but not so much about the detailed work of directors that mostly occurs in committees. In particular, all boards, especially in Western cultures, have committees that identify new board members and facilitate CEO search processes (nominating and governance committees), set executive compensation (compensation committee), and oversee financial reporting (audit committee). These three dominant committees are today required by public stock exchanges and the SOX Act. The SOX Act additionally requires that they be headed by independent outside directors—those that are not inside managers and have no stakeholder affiliation (such as legal representation or customer or supplier relationship). The three committees, part of the audit culture, function to protect shareholders and other stakeholders from managerial malfeasance. Managers should not have the power to nominate board members that supervise their decisions, set their own compensation, or make aggressive or fraudulent accounting decisions.

In theory, shareholders appoint directors. In practice, however, shareholders simply ratify director candidates selected by the board's nominating committee, although the proxy voting process has become increasingly complex due to activist discontent.³⁴ As described in more detail in the Strategic Governance Highlight (Box 1.3), activist board members are elected to targeted boards and often represent wolf pack hedge funds who have teamed together. These board members push for share price increases and other activist agenda items, which may come at the expense of other stakeholders. The nomination process is hence critical in making appropriate director appointments, as the effectiveness of the board with regard to its monitoring role depends on the quality of the board members selected.³⁵

BOX 1.3 Strategic Governance Highlight: How Did Boards Become More Activist-Oriented?

      The 1980s was known for hostile takeovers and the use of junk bonds to facilitate large takeovers by corporate raiders. This period inspired a book and movie titled Barbarians at the Gate, which chronicles the takeover by Kolberg, Kravis, and Roberts (KKR) of RJR Nabisco in a stunning $24 billion deal. However, in the early 1990s, the market for corporate control became dampened after the collapse of the junk bond market and the jailing of Michael Milken and the failure of his firm, Drexel Burnham Lambert.

      In the late 1990s, institutional investors, such as pension funds and mutual funds, became more active. Although institutional investor activism rose in this period, the market for corporate control declined because of defensive actions by boards that largely insulated firms from pressure. But activist hedge funds stepped in with more offensive actions. In the 2000s, activist hedge funds began to nominate unaffiliated board members and influence their election to boards. One legal observer called this approach quasi-control because it uses board power rather than just ownership voice, as pension fund holders had used in the 1990s, although it falls short of actual corporate control. When activist fund representatives fill one or more board seats, their influence often leads to the replacement of significant corporate managers, such as the CEO or CFO, and the replacements often favor the strategic decisions preferred by the activists.

      In wolf-pack activism, funds ready for aggressive campaigns team together with other activist investors. This tactic may include securing minority board representation (especially by way of negotiated settlement), which represents a much cheaper alternative to engaging in a proxy contest or pursuing a hostile takeover. In this manner, activist hedge funds can pursue a number of different companies compared to focusing their efforts entirely on one or two targets. As such, the amount of capital that they need to invest in specific target companies has gone down over time.

      What regulatory and other changes occurred to allow for an atmosphere of wolf-pack activism? Changes in Securities and Exchange Commission regulations and the entrance of shareholder proxy advisory intermediaries facilitated the changes. The SEC enacted a proxy access rule in 2010, though it was later vacated by the US Court of Appeals for the District of Columbia Circuit in 2011. However, in recent years, many S&P 500 companies have adopted proxy access bylaws, which usually allow shareholders who hold 3 percent of the shares of a company for at least three years the ability to nominate directors without going through a proxy contest. Rather than risk a proxy contest, firms have allowed more access to the nomination process. In fact, 88 percent of the board seats won in 2016 were achieved through settlement agreements rather than proxy contests, compared to 70 percent in 2013 and 66 percent in 2014.

      Proxy advisory intermediaries, such as Institutional Shareholder Services (ISS) and Glass Lewis, have enabled the power of other institutional investors, often in support of the activist shareholders. Because institutional investors are significant shareholders, often having shares over the SEC 3 percent rule, they hold power to nominate directors directly during the proxy voting process. And because institutional investors frequently follow large proxy advisor voting recommendations, activist investors

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