The Role of the Board of Directors as a Part of Corporate Governance

The board of directors in NOCs may be critical because their decision-making power can transform the position of the company in the market. In other words, robust corporate governance can increase the level of supervision over the company’s performance, efficiency, and integration into the competitive market environment.

In its broadest definition, corporate governance is “all the influences affecting the institutional processes, including those for appointing the controllers and/or regulators, involved in organizing the production and sale of goods and services” (Turnbull 1997).

The concern of corporate governance is to preserve the mechanism which helps owners and shareholders to control corporate insiders and management through legal institutional and cultural mechanisms (Shleifer and Vishny 1997; John and Senbet 1999). A wealth of studies demonstrate the relationship between specific corporate governance characteristics and firm value (Yermack 1996; Core, Guay, and Rusticus 2006;

Chhaochharia and Grinstein 2007; Bebchuk, Cohen, and Ferrell 2009).

The board of directors, as a major component of corporate governance, has a significant role in sustaining an effective organization (Fama 1980; Fama and Jensen 1983; OECD 1999; Jensen 1993). The different roles the board of directors play can be collapsed to three main categories: service, strategy, and control (Zahra and Pearce 1989). As part of its service role, boards have the responsibility to represent a firm’s interest in the community, increase the connection of the firm with its external environment and pursue regular activities to sustain the functionality of the company (Zald 1969; Pfeffer 1972;

Mintzberg 1983). These service activities of the board of directors constitute ways to enhance the company’s identity, reputation, commitment to its mission, and most important of all, to ensure its survival (Provan 1980). As part of their strategic role, boards have the responsibility to be a part of mission development of the company, selection and implementation of the company’s strategy (Judge and Zeithaml 1990). The primary purpose of the board of directors, stemming from this strategic role is to increase the competitiveness of the company and to maximize shareholders’ wealth (Brickley and James 1987). Besides, the strategic role is important in the sense that it sets a specific target for the company. The last role of the board of directors is to control the executive body of the company. It has the power to monitor, evaluate and reward executives and their performance to protect the interests of shareholders, and to decrease agency costs,

which can arise because of the duality in the ownership and control (John and Senbet 1999).

Although almost all of the boards of directors across industries officially carry these roles, not all of them perform each of these functions at the same level of effectiveness. Several factors determine board effectiveness, such as size, composition, and level of independence (John and Senbet 1999). No consensus in the literature exists about the effect of the size of the board. According to Lipton and Lorsch (1992) and Jensen (1993), as the size of the board expands, their capacity for monitoring increases due to increasing levels of expertise in the group. Yermack (1996), though, finds an inverse relationship between the size of boards and the firm value. Similarly, several studies indicate that as the size of boards enlarges, the decision-making process of the board will be harder (Goodstein, Gautam, and Boeker 1994; Eisenberg, Sundgren, and Wells 1998; Forbes and Milliken 1999).

A close relationship seems to exist between the two significant factors of effectiveness;

the composition of the board seems to affect its level of independence from shareholders (John and Senbet 1999). Therefore, these two factors can be discussed together. The organizational management literature on board composition primarily focuses on the ratio of insider-outsider (independent) members (Pfeffer 1972; John and Senbet 1999; Van Den Berghe and Levrau 2004). Insider board members usually belong to two of the following groups: members who represent the owner with a major commercial interest in the firm or the foreign shareholders of the firm (Baysinger and Butler 1985). Outsider members, who are independent of the ownership structure, are elected by shareholders, employees, or an assembly which is responsible for the election of board members (Hermalin and Weisbach 1988). The purpose is mainly to create a check and balance system in the governance structure of companies and to show companies’ willingness to comply with international corporate governance standards (Baysinger and Butler 1985).

According to the findings of many studies, provided that the minimum number of insider members is preserved, the increase in the number of outsider members enhances a firm’s performance (Daily and Dalton 1994; Hermalin and Weisbach 2000; Johnson, Hoskisson, and Hitt 1993; Baysinger and Hoskisson 1990).

The insider-outsider classification is not always sufficient to understand the effect of diversification in board composition. Certain demographic criteria, such as gender, age, race, ethnicity, and nationality seem to have an impact on firm performance (Erhardt, Werbel, and Shrader 2003; Shrader, Blackburn, and Iles 1997). Several studies indicate that demographic diversity in its board increases the performance of a firm (Pearce and Zahra 1992; Finkelstein and Hambrick 1996; Bonn, Yoshikawa, and Phan 2004; Carter, Simkins, and Simpson 2003; Erhardt, Werbel, and Shrader 2003). Among studies that examine board composition, the number of studies that specifically focus on nationally of members is relatively small.

Having an international board carries many potential advantages (Randoy, Thomsen, and Oxelheim 2006). The presence of international board members gives international shareholders confidence that their investment will be adequately monitored (Rosenstein and Wyatt 1990). Independent international members, who do not necessarily represent shareholders, may also ease the company’s access to foreign investment since the presence of such members sends a signal to companies in the global market that the firm complies with global standards. Therefore, having a foreign member on the board is a step for the globalization process of the company (Oxelheim and Randøy 2003).