New research suggests that the most favorable conditions for innovation occur when boards do not monitor the CEO intensely but focus on strategic advising.
The high-profile scandals of the late 1990s have transformed the corporate governance landscape and increased the oversight duties of independent directors. New mandates, such as the Sarbanes-Oxley Act of 2002, have had substantial effects on corporate boards. For one thing, they dramatically increased the workload of directors serving on audit, compensation and nominating committees. In addition, the number of independent directors serving on multiple committees has expanded greatly, from 48% in 2000 to 61% in 2011.
The shift toward increased monitoring raises two important questions. First, has the increased focus on board oversight helped to improve the quality of board monitoring? Second, can board oversight become excessive and ultimately detrimental to desirable objectives?
This article focuses on three distinct aspects of oversight responsibility: design and implementation of suitable executive compensation packages; removal of underperforming CEOs; and disclosure of earnings that reflect the company’s true financial conditions. In a study of S&P 1500 companies, boards were able to perform these functions most effectively when they devoted significant resources to managerial oversight. Board oversight improved when independent directors devoted the time and resources envisaged by the new regulatory regime.
However, the most favorable conditions for innovation occurred when the board did not monitor the CEO intensely but focused on strategic advising, thereby encouraging the CEO to pursue valuable but high-risk innovation projects. Conversely, corporate innovation suffered when the board monitored intensely. Companies with such boards invested less in R&D, received fewer patents overall and received fewer influential patents as measured by the frequency of citations of the patents they received. In addition, company value was lower when the board devoted greater time to oversight.