Boards of Directors, Corporate Governance

Boards of Directors, Corporate Governance and Market Value of the Firm. Do Shareholder profit from Board Reforms driven by Regulators? Evidence from Switzerland

The concept of firm

The agency problem

Definition of corporate governance

Mechanisms of corporate governance

Literture review - Part II

Board of directors - introduction

Models of boards

One-tier vs. two-tier board model

The case of Switzerland

CEO duality

Outsider directors / board independence

Board size

Board committees

Interlocking directorates

Multiple board appointments

Frequency of board meeting

Board diversity

Regulatory development

The case of Switzerland

Board index

Board impact on firm valuation

Performance measure

Long-term equity return

Current board structure

Potential research problem

Ethical issues of the proposed research

Expected research outcomes

Abstract

The proposed research focuses on a fundamental element of the corporate governance process, the board of directors. In particular, the research addresses the question whether boards of directors as the "apex" of the organization increase firm value.

This paper outlines the research proposal which seeks to explore whether good board governance leads to higher common stock returns for Swiss companies. The research will involve the construction of a survey-based "Board Index" using provisions based on a Code of Best Practice portfolios consisting of companies that conform with the code and others that do not conform to best practice are constructed and then stock-returns are compared.

Introduction

The proposed research focuses on a fundamental element of the corporate governance process, the board of directors. As the literature review will show, the arena of corporate governance is very large, encompassing countless issues that academics have struggled with for years. Corporate governance addresses the agency problems that are induced by the separation of ownership and control and are prevalent in the contemporary corporation worldwide (Berle & Means, 1932; Jensen and Meckling; 1976; Gompers et al., 2003). According to Fama (1980) agency problems are the necessary evils of an "efficient form of economic organization" called firms where the various resource owners are pooled together in order to produce goods or services demanded by customers at the lowest cost. Therefore, boards of directors must be convinced of the importance of grappling with and managing corporate governance for their long-term survival and growth.

The board of directors is an important institution in the governance of modern corporations. Fama and Jensen (1983) view the board as "the apex of internal decision control systems of organizations." The fundamental role of the board is to control managerial behaviour and ensure that managers act in the interest of the shareholders. Being the "apex" of the organization the board is responsible for the firm specific corporate governance framework.

The board of directors has received considerable attention from academic researchers (Dalton et al., 1998; Zahra & Pearce 1989). In particular, studies on board composition and board leadership structure and its relationship to firm performance have accounted for the bulk of research (Zahra and Pearce, 1989, Johnson, Dailly and Ellstrand, 1996; Forbes and Miliken, 1999; Huse 2000, Hermalin and Weisbach, 2003). Empirical findings of the board's impact on firm performance have been inconclusive (Bhagat and Black, 1999; Dalton et al., 1998).

Nevertheless, corporate boards are the focus of many attempts to improve corporate governance. Regulators and shareholder advocates in the U.S. have called for smaller boards with greater outside representation among U.S. corporations (The Business Roundtable 1997). This movement toward specific board guidelines, typically calling for greater independence, independence outside representation, and requirements that boards have audit committees that consist only of independent outside directors, is a characteristic of the Codes of Best Practice issued in many countries (Denis & McConell, 2003). In Switzerland, for example, the "Directive on Information Relating to Corporate Governance" and the "Swiss Code of Best Practice" have become a listing requirement on the Swiss Stock Exchange as of July 1, 2002. Yet despite the extensive research, there is no clear empirical evidence that shareholders benefit from these regulations.

The proposed research addresses a number of important issues relating to corporate governance, board of directors, firm value and the relationship between these in Switzerland. Foremost, among these research questions is: Do well-governed boards of directors, measured in regulator's terms, increase long-term equity returns?

A test can be carried out in order to evaluate the hypothesized relationship between board governance quality and firm valuation; a board-index may then be constructed based on a survey of all listed companies on the Swiss Stock Exchange (SWX) (Beiner, p. 3). Based on this index, portfolios can be built, consisting of companies with well-governed or poorly governed boards. In addition, following the portfolios, a comparison of their long-term equity returns may be done (Beiner, p. 3).

It was only until recently that the development of a governance index has become popular in the literature research. For example, Drobetz, Schillhofer and Zimmermann (2003) in Germany, Zimmermann et al. (2004) in Switzerland and Gompers, Ishii and Metrick (2003) in the U.S., construct a corporate governance index and analyze the relationship between corporate governance and long-term equity return. The authors report that well-governed companies have proven to have higher equity returns, are valued higher and have accounting statements that show a better operating performance in the end.

Although the proposed research has similarities to the work of Drobetz, Schillhofer and Zimmermann (2003) and Gompers et al. (2003), the research design differs in an important aspect: the different focus on corporate governance. In this study the centre of attention is the board of directors and not overall corporate governance. The logic behind this approach is that the board of directors is the "apex" of the organization and, therefore, determines the company's overall corporate governance framework. A poor governed board would, ceteris paribus, most likely create a poor governance framework. The proposed study is, in certain ways, an update of the Zimmermann et al. (2004) research which surveyed Switzerland for the year of 2001 and 2002.

The major contributions of the proposed research to the literature are:

This study measures the impact of well- and poorly governed boards on their long-term equity return:

This study uses a data set from an institutional environment different than most available empirical evidence;

This study describes the characteristic of boards of directors in Switzerland that are relevant for regulators;

This study shows to what extent boards comply with best practice.

The remainder of this paper is organized as follows. Section 3, 4, 5 and 6 summarize the main body of the relevant literature, namely corporate governance, board of directors, the current research based on governance indices and the regulatory development. Section 7 draws a conclusion and presents the objectives of the proposed research. In section 8, the research design is presented. Finally, section 9 presents the expected research outcomes.

Literature Review - Part I

The literature review is divided into three parts. The first part discusses the theory of the firm, the agency problem and corporate governance. The second part introduces the board of director because this research focuses on this fundamental element of corporate governance. The third part summarizes the recent research about the impact of individual countries' corporate governance rules or corporate practice on individual firm's value and performance.

This first section of the review addresses the theory of the firm. Popular theories and their attempt to describe the firm, as well as its boundaries, are reviewed here. This section provides the necessary background to understand what exactly is being governed. It is appropriate that a study on corporate governance begins by looking at the firm itself.

The next section addresses the agency problem which has a great relevance for corporate governance. The section reviews the agency problem from various points-of-view and explains why corporate governance is so important. This discussion leads then into the detailed discussion of corporate governance and its legal and economic forms. Of particular interest for this research project is the outline of the economic forms of corporate governance. These forms are the building blocks available to the board of director to create firm value through good governance. Thus, this discussion of corporate governance is essential to understand the proposed research.

The concept of the firm

What is the "animal" we are trying to govern? Numerous theories have been developed over the years, some building on each other, and other in conflict. The theories of the firm to be identified in this review include, Coase's ground breaking rational for the existence of the firm, Demsetz's presentation of the pure economic theory of the firm, and Williamsons' idea of the firm as a governance structure explained via transaction cost economics. A brief review of mechanism design, the classical model of the entrepreneur, and the property rights theory of the firm are also considered. Finally, the firm as a nexus of contracts as explained by Jensen and Meckling will conclude the discussion.

As discussed above, there are several theories of the firm and its boundaries. One of the more popular and most cited accounts comes from Ronald Coase (1937). Coase argued "that a firm is not an organization but an organism, automatically regulated by the price mechanism. In contrast, within the firm, the entrepreneur directs production and coordinates without intervention of a price mechanism; but, if production is regulated by price movements, production could be carried on without any organization at all, well might we ask, why is there any organization?" (Coase, 1937, p. 387) In simpler words if markets are so efficient why do firms exist? Coase explains, "the operation of a market costs something [such as the costs of negotiating and concluding a separate contract for each exchange transaction] and by forming an organization and allowing some authority (an "entrepreneur") to direct the resources, certain marketing costs are saved" (Coase, 1937, p. 391). Thus, firms actually present greater efficiency over markets by decreasing such costs.

That being said, if firms are so efficient, why are markets needed? (Coase, 1937). As per Coase, as the firm grows (when the entrepreneur processes additional transactions), decreasing returns to scale may occur. This development is possible for three reasons: (1) coordination costs may increase until eventually the firm is indifferent between integrating transactions and purchasing through the market; (2) the entrepreneur may fail to make the best use of the factors of productions; (3) "the supply price of one or more of the factors of production may rise, because the "other advantages" of a small firm are greater than those of a large firm" (Coase, 1937, p. 394). These three decisions are what determine when a firm should integrate or when it should rely on the market, in other words, the make or buy decision.

In contrast to Coase, Harold Demsetz (1983) looks at the firm from the perspective of the pure economic theory. He argues that there is a difference between real firms and firms according to economic theory, the latter being lean, no-nonsense institutions devoid of managerial amenities vs. real firms, which Demsetz describes as largely controlled by management possessing insignificant interest in the profitability of the firm's activities: "the [real] firm may seek to keep shareholders content with a minimum acceptable positive return, but beyond that, profit is traded off to increase the utility of management" (Demsetz, 1983, p. 377). Demsetz explains that two divisions of resources exist, production vs. consumptions. Households are defined as a theoretical institution in which rational decisions about consumption take place. The firm, on the other hand, is defined as a theoretical institution in which production (for others) take place. Both are considered to be specialized in their functions. Consumption is said to create utility and therefore households are concerned with utility increasing decisions. In addition, firms are concerned with profit maximization, which is accomplished by indirectly delivering utility creating consumption capability.

Oliver Williamson's (1981) position is to assess alternative governance structures of which firms and markets are the leading choices in terms of their capacities to economize on transactions costs. The discipline of transactions costs economics (TCE) is the means by which Williamson defines the firm and its operations: "The transactions cost approach to the study of economic organization regards transactions as the basis unit of analysis and holds that an understanding of transaction cost economizing is central to the study of organizations" (Williamson, 1981, p. 548). According to Williamson, the TCE approach addresses the firm at three different levels. First, it addresses the overall structure of the firm to determine how operating parts should be related to one another. Second, the middle level focuses on operating parts of the firm to determine which activities should be performed within the firm, outside the firm and why. In other words, the boundaries of the firm are defined at this stage. Third, TCE is also concerned with the manner in which human assets are organized and identifies appropriate governance structures given the attributes of particular work groups. Williamson claims the following proposition applies quite generally such that "governance structures that have better transaction cost economizing will eventually displace those that have worse, ceteris paribus" (Williamson, 1981, p. 574).

The boundary of the firm according to TCE is as follows..." The firm begins with "core technology," within which integration is treated as unproblematic. Forward, lateral, and backward integration, in relation to the core, are then examined" (Williamson, 1998a). For example, the firm can choose to employ backward integration into raw material vs. procuring raw material from others. Williamson explains this further by asking whether the firm will produce its own components or buy them in the market. Will the firm integrate forward into distribution or will it rely on the wholesale and retail capacities of others:.." The actions resides in the attributes of transactions in relation to the cost on the one hand and competencies of alternative modes of governance on the other" (Williamson, 1998a).

The relationship between the firm, its governance, and TCE can best be summed up by the following hypothesis: "transactions, which differ in their attributes, are aligned with governance structures, which differ in the cost and competence, so as to effect a (mainly) transactions-cost economizing result" (Williamson, 1998b). Williamson explains that governance is the means by which order is accomplished in a relationship in which potential conflict threatens to undo or upset opportunities to realize mutual gains.

There are however several remaining theories in contrast to Williamson's idea of the firm as a governance structure. These include: "...mechanism design (where a menu of contracts is used to elicit private information), agency theory (where risk aversion and multitasking are featured), the classical model of the entrepreneur and the property rights theory of the firm (where everything rests on asset ownership)"

Of these contrasting propositions the agency theory will be reviewed in more detail in the following section because of its relevance to corporate governance. The classical model of an entrepreneur proposes that the owner-manager operates the firm to maximize profits (Baumol, 1959). Therefore, the firm is controlled and owned by the same person:.." this literature fails to explain the large modern corporation in which control of the firm is in the hand of managers who are more or less separate from the firm's security holders" (Fama, 1980, p. 289).

With regard to property rights theory of the firm, Fama explains that: "The firm is viewed as a set of contracts among factors of production, with each factor motivated by its self-interest" (Fama, 1980, p. 289). In essence, the firm is a team of cooperating factors of production and the concept of ownership of the firm under this view is irrelevant because:.." control over the firm's decisions is not necessarily the province of the firm's security holder" (Fama, 1980, p. 290). In fact, the manager is separate form the risk bearer (residual claimants), as each are separate factors of productions. Fama asserts this view is more appropriate for the modern corporation.

Jensen and Meckling (1976) describe the firm as a nexus of contracts and argue that most organizations are simply legal fictions serving as a nexus for a set of relationships between individuals. To them, the firm "serves as a focus for a complex process in which the conflicting objectives of individuals (some of whom may "represent" other organizations) are brought into equilibrium within a framework of contractual relations" (Jensen and Meckling, 1976, p. 309). Furthermore, no two firms will have the same "nexus of contracts." This notion of contracts is also extended to the theory of property rights. "...specification of individual rights determines how costs and rewards will be allocated among the participants in any organization [but]...the specification of rights is generally effected through contracting" (Jensen and Meckling, 1976).

The agency problem

Agency theory is probably one of the most discussed topics in firm research. Shleifer and Vishny (1997), explain the agency problem as one of ensuring that financial suppliers' capital not be expropriated or wasted. They explain that even though a contract is drafted outlining the indented use of such funds, contracts are ultimately flawed because agents and owners are unable to foresee everything, thus making contracts inevitably incomplete. Control is then usually allocated to the managers for occurrences unforeseen in the contract; therefore, "...managers end up with significant control rights (discretion) over how to allocate investors' funds" (Shleider and Vishny, 1997, p. 742). Jensen and Meckling (1976) define an agency relationship as "a contract under which one or more persons (the principal(s)) engage another person (the agent) to perform some services on their behalf which involves delegating some decision making authority to the agent" (Jensen and Meckling, 1976, p. 309).

It is Fama and Jensen (1983) however who really break down the separation of ownership and control. They describe the organization as "...the nexus of contracts, written and unwritten, among owners of factors of production and customers. These contracts or internal "rules of the game" specify the rights of each agent in the organization, performance criteria on which agents are evaluated, and the payoff functions they face" (Fama and Jensen, 1983, p. 2).

Central contracts consist of two components: residual claims and the decision process. The decision process encompasses four steps: (1) initiation of proposals for resource utilization; (2) ratification or choosing initiatives to be implemented; (3) implementation of ratified initiatives; and (4) monitoring decision agents' performance and implementing rewards. Steps (1) and (3) are considered decision management while step (2) and (4) are decision control.

Fama and Jensen (1983) argue that an effective system is in fact one that separates decision management from control, but problems (agency costs) occur when managers are not residual claimants. They suggest the separation of decision management, decision control, and residual risk bearing when the firm is complex or large. Three benefits can arise from doing this: (1) the diffusion of specific knowledge or the delegation of decision management to agents with valuable relevant knowledge, (2) diffused residual claims since complex firms would incur great cost for the many agents to be involved in decision control; and (3) a limit on the power of individual decision agents to expropriate the interests of residual claimants. The board of directors is one mechanism used to separate management and control decisions.

However, in small non-complex firms it may be "efficient to combine decision management and control functions in one or a few agents" (Fama and Jensen, 1983, p. 28). This is likely due to resource constraints.

Williamson (1993) presents support for Fama and Jensen's (1983) theory of decomposition, the act of distinguishing between decision management and decision control. However, Williamson is also a strong proponent of diffuse decision control, that is, allowing strategic decision making to permeate the organization. The problem with Williamson's views is that they contradict each other, as one cannot have diffused decision control and decomposition at the same time. This is one downside to Fama and Jensen's theory because it does not admit the possibility of gains due to diffuse decision control that Williamson argues exists.

Agency cost includes residual loss, monitoring and bonding expenditures or more specifically the cost of auditing, formal control systems, budget restrictions, and the establishment of incentive compensation systems. In essence, agency costs arise because of an inability to draft a perfect contract. According to McColgan (2003), there are three reasons why agency costs may occur. The first is moral hazard. This arises as managers' equity stakes decrease possibly causing their work incentive to also diminish. The second is earning retention. Since remuneration is an increasing function of company size, management has an incentive to focus on growth in the size of the firm rather than on shareholder returns. Jensen (1986) furthers this by arguing that managers prefer to retain earnings vs. shareholders who favour higher levels of cash distributions. This is particularly problematic when the company has few positive net present value (NPV) investment opportunities. The third and final reason is risk aversion. Since investors can diversify their holding, they posses a different risk view of risk as compared to the managers whose wealth is tied to stock of the company they manage, thus they often avoid taking on risk, even in the form of positive NPV projects.

Now that we know why agency costs arise and what they are, it is important to note how they occur. Shleifer and Vishny (1997) state that manager end up with significant control rafts (discretion) over how to allocate investors' funds. As such, three ways of expropriation exist: First, the manipulation of transfer pricing, second, entering into projects that benefit managers instead of the firm, and third management entrenchment or staying on the job beyond their competency.

Harold Demsetz's (1983) view on the separation of ownership and control is more optimistic than most. First, Demsetz claims that on-the-job consumption by employees is mutually advantageous because the employee pays for his amenities by accepting lower compensation, and since the goods employees consume on the job are produced at as low an opportunity cost as possible this then complies with the profit maximization assumption. Second, shirking is identified as a non-activity and as a direct result monitoring costs exist. In a firm that has high monitoring costs.." take-home pay will be lower than for the same quality group of employees employed in a low monitoring cost firm" (Demsetz 1983, p. 381). Consequently, it is no longer clear that diffuse ownership give rise to high costs since there is substitution between on-the-job-consumption and take-home pay. One stylised fact is that monitoring costs increase the more broadly based the ownership of the firm becomes. While this may be true, the foregoing arguments suggest that take-home pay will be adjusted for those monitoring costs so that the sum of monitoring costs and take-home pay for a group of like quality managers will be the same in both a narrowly owned firm and a broadly owned firm. The deployment of resources may however differ between take-home pay, on the job consumption, monitoring costs, and shirking.

While Demsetz is not arguing there is a perfect correlation between the interests of owners and managers, he makes it clear that there is an ongoing interest in profit maximization behaviour. Furthermore, "In a world in which self-interest plays a significant role in economic behaviour, it is foolish to believe that owners of valuable resources systematically relinquish control to managers who are not guided to serve their interests" (Demsetz, 1983, p. 390).

Berle and Means (1932) identify a problem with the separation of ownership and control that is an antecedent to agency costs, and in some cases may actually lead to them "The separation of ownership form control produces a condition where the interests of owner and of manager may, and often do, diverge, and where many of the checks which formerly operated to limit the use of power disappear.." (Berle and Means, 1932 - cited in Demsetz, 1983, p. 375). In a related note Shleifer and Vishny (1997) explain that management discretion has limits and these limits take the form of corporate governance.

In essence, the existence of the agency problem advocates the fundamental function of corporate governance to control managerial behaviour and ensure that managers act in the interest of shareholders.

Definition of corporate governance

According to the Patterson report, within the past two decades or so, there had been little academic interest in corporate governance (2003). In addition, now there is an almost exponential increase in studies about various aspects of corporate governance. Corporate governance is now currently one of the wealthiest and an area that is most varied within the field of academic research. Scholars from a variety of fields, such as business, accounting, economics, finance, law and sociology are doing research studies and workshops based on these various discipline areas held around the world.

The American Management Association's (1981) definition of corporate governance is:

Corporate Governance ensures that long-term strategic objectives and plans are established and that the proper management structure (organization, systems, and people) is in place to achieve those objectives, while at the same time making sure that the structure functions to maintain the corporation's integrity, reputation, and responsibility to its various constituencies."

Cochran and Wartick (1988) described corporate governance as an umbrella term that covers many aspects related to concepts, theories and practices of boards of directors on the relationship between boards, shareholders, top management, regulators, auditors and other stakeholders.

The Organization for Economic Co-operation and Development (OECD) described corporate governance as the way in which boards oversee the running of a company by its managers, and how board members are in turn accountable to shareholders and the company. This has implications for company behaviour towards employees, shareholders, customers and banks. Good corporate governance plays a vital role in underpinning the integrity and efficiency of financial markets. Poor corporate governance weakens a company's potential and at worst can pave the way for financial difficulties and even fraud. If companies are well governed, they will usually outperform other companies and will be able to attract investors whose support can help to finance further growth" (www.oecd.org, June 2004).

In summary, these and other definitions indicate that the field of corporate governance is a rich one. As stated by Tricker (1993, p.2), corporate governance can mean many things to those concerned. Institutional investors have a different perspective from corporate regulators, board members from researchers. Insights can be drawn from the professional and theoretical worlds of organizational behaviour, jurisprudence, financial economics, accountancy and auditing, as well as from the experiential worlds of director behaviour and board practices."

The implication for this research is that the literature review needs to cover the terms "corporate governance," "board of directors" and "regulatory development" in order to create a common language within the research. Many of these terms and definitions are used in similar but not identical ways in the literature. There is, therefore, a need to define these terms.

Mechanisms of corporate governance

This section outlines the various corporate governance mechanisms where corporate governance can be classified into two main categories: economic and legal/regulatory. These available mechanisms are the building blocks for the board of directors to create the most appropriate corporate governance framework for the company.

One could take a view that we should not worry about corporate governance systems, as, in the long run; competition would take care of corporate governance (Stigler, 1958). Although product market competition is probably the most powerful factor leading to economic efficiency in the world, it does not assure that investors get an adequate return on their financial investment also in the short run. Therefore, additional corporate governance measures are necessary.

Jensen (1993) outlines four basic categories of individual corporate governance mechanism:

1) legal and regulatory mechanisms are corporate governance mechanism outside the firm with a system of laws and regulations that govern the company. The most important legal right shareholders have is the right to vote on important corporate matters, such as mergers and liquidations, as well as in elections of board of directors. Voting rights, however, turn out can be expensive to exercise and to enforce (Shleifer and Vishny, 2001). For example proxy contests rarely result in a change of control. Dodd and Warner (1983) found that within a sample of 96 contests unrelated to takeover bids between 1962 and 1978 only 18 resulted in a change of control;

2) internal control mechanism has been the subject of much public interest and extensive academic research. Within a company the primary mechanisms that influence the degree to which management represents shareholders' interest are the board of directors and the firm's ownership and debt structure. These are examined in more detail below.

Boards of directors, which are in position to hire and fire top management as well as to observe and control key decisions and hence to constrain managerial self-interest on behalf of the shareholders, are monitoring mechanism (Frankforter et al., 2000). Countries require companies to have a board of directors. Thus, basically, having a board of directors is a legal requirement. The legal requirements are often expressed as a minimum requirement. The law normally does not always explicitly outline in detail the number of directors, their backgrounds and relation to the company or how the board should function.

Stock ownership, contingent executive compensation and "golden parachutes" are thought to create incentives for managers to act in the interest of shareholders and are called interest-aligning devices (Frankforter et al., 2000). Recent surveys by Core et al. (2001) and Murphy (1999) provide extensive and up-to-date summaries of the issues and the existing evidence on executive compensation and ownership.

Debt is described by literature as a mean of reducing the conflict of interests between managers and shareholders. Shleifer and Vishny (1997) survey this literature. In essence, debt reduces the agency cost of free cash flow by reducing the cash flows available for spending at the discretion of managers. This is particularly useful in mature-companies that produces high level of cash, but do not have a lot of positive net present value projects where they could invest the cash (Jensen, 1986).

3) External control mechanisms are a haven of last resort in the event that legal and internal control mechanisms do not lead management to maximize the value of publicly traded companies. The market for corporate control is in place to replace incompetent or dishonest managers with groups or individuals who can take control of the company, often by purchasing a large proportion of its stock on the open market (Jensen 1993);

4) Product and factor market competition requires companies to produce products that people desire at a competitive price. Management wastefulness and/or inefficiency that interfere with the ability to do so will be reflected in poor performance in its product markets and a high cost of capital due to the lack of the protection that a good system of corporate governance will afford investors (Denis, 2001). Jensen (1993) argues that while the product and factor markets are slow to act as a control force, their discipline is inevitable in the longer run.

Literture review - Part II

The next section addresses the board of directors - the focus of this research and an important part of corporate governance. The review of the literature sheds lights on an institution that can be defined as a collective group of individuals elected by the shareholders of a corporation to oversee the management of the corporation. In particular, the review covers the two prevailing approaches to the organization of corporate boards (one-tier board model and the continental European two-tier board mode) and various topics related to the structural debate about boards of directors. This section provides the background to the many attempts to improve corporate governance through specific guidelines and rules promulgated by regulators.

Board of directors - introduction

Of importance to the proposed research is the recognition that board of directors are an essential component of corporate governance (Maassen, 2002). For Roades, Rechner and Sundaramurhty (2000) corporate boards are a key internal governance mechanism and, as noted above, Fama and Jensen (1983) view the board as "the apex of internal decisions control system of organizations."

The board of directors is charged with insuring that top management carry out their duties in the best interest of owners (Fama, 1980; Jensen and Meckling, 1976). Fama and Jensen concluded that the separation of decision management (the initiation and implementation of decisions) from decision control (the ratification and monitoring of decisions) in the organization is the major device that limits the costs due to the separation of "ownership and control" (Table 1).

Table 1: Decision Management (Brickley et al. 1997, p.207)

Category

Decisions step

Definition

Decision management / Management rights

Initiation

Generation of proposals for resource utilization and structuring of contracts

Implementation

Execution of ratified decisions

Decision control / Control rights

Ratification

Choice of the decision initiatives to be implemented

Monitoring

Measurement of the performance of decision agents and implementation of rewards

To the extent that boards are not dominated by executive directors, firms use a common device, the boards of directors, to accomplish such separation at the top level of the organization. Boards have the right to ratify and monitor the decisions that are initiated and implemented by top management. In addition, they have the power to hire, fire, and set the compensation of the top-level managers. Moreover, having a board is one of the legal requirements for incorporation in almost all countries. As explained below, in practice this separation is not always clear because there are members of the executive management who are also members of the board.

Models of boards

One-tier vs. two-tier board model

Regional and international developments have resulted in two leading approaches to the organization of corporate boards: the Anglo-Saxon one-tier board model and the continental European two-tier board model (Massen, 1999).

In general, Anglo-Saxon countries such as the U.S., the UK and Canada have adopted variants of the one-tier board model. In this model, executive directors and non-executive directors operate together in one organizational layer (the so-called one-tier or unitary board). Some one-tier boards are dominated by a majority of executive directors while others are composed of a majority of non-executive directors. In addition, one-tier boards can have a board leadership structure that separates the CEO and chair positions of the board. One-tier boards can also operate with a board leadership structure that combines the roles of the CEO and the chairman (known as CEO duality). One-tier boards also often make use of board committees like audit, remuneration and nomination committees.

Continental European countries such as Germany, Denmark and the Netherlands have adopted variants of the two-tier board model. In this model, an additional organizational layer has been designed to separate the executive function of the board from its monitoring function. The supervisory board (the upper layer) is entirely composed of non-executive supervisory directors who may represent labor, the government and/or institutional investors. The management board (the lower layer) is usually composed of executive directors. Generally, it is not accepted by corporation laws that firms combine the CEO and chairman roles in two-tier boards. Because the CEO has no seat on the supervisory board, its board leadership structure is formally independent from the executive function of the board. This is particularly the case in two-tier boards in the Netherlands and Germany. In variants of the two-tier board model in these countries, executive managing directors are not entitled to have a position in the supervisory board of the corporation.

The case of Switzerland

Switzerland is located in the middle of Europe and is surrounded by countries using the two-tier board model (Germany, Austria) and the one-tier model (France, Italy). Switzerland has adopted the one-tier board model.

The board of directors may take decisions on all matters that by law or the Articles of Incorporation are not allocated to the shareholders' meeting. The board manages the business of the company insofar as it has not been delegated to management (Art. 16 Swiss Code of Obligations (CO)). However, the board of directors has certain non-transferable and inalienable duties which include: the ultimate management of the company; the system of financial controls; and the preparation of the annual report and accounts.

As a general rule, the board of directors delegates day-to-day management to individual members or third parties (Art. 716b CO). Delegation of management must be authorised in the company's Articles of Incorporation and precisely defined in organisation regulations to be issued by the board of directors.

CEO duality

Fama and Jensen (1983) argue that concentration of decisions management and decision control in one individual reduces a board's effectiveness in monitoring top management.

However, relating CEO duality more specifically to firm performance, researchers find mixed evidence. Daily and Dalton (1992) find no relationship between CEO duality and performance in entrepreneurial firms. Brickley et al. (1997) also show that CEO duality is not associated with inferior performance. In contrast, Rechner and Dalton (1991) report that a sample of Fortune 500 companies with CEO duality have stronger financial performance relative to other companies. Goyal and Park (2002) examine a sample of U.S. companies and find that the CEOs are more likely to be sacked in the absence of duality.

An interesting proposition is presented by Faleye (2003). He argues that no "one hat fits all" and board leadership structure depends entirely on individual firm characteristics such as organizational complexity, the availability of other controls over CEO authority and CEO reputation and power. Using a sample of 2,166 U.S. companies, he finds that companies with complex operations, alternative control mechanisms and sound CEO reputation are more likely to have CEO duality.

Outsider directors / board independence

Although the issue of whether directors should be employees of or affiliated with the firm (inside directors) or outsiders has been well researched, no clear conclusion is reached. On the one hand, inside directors are more familiar with the firm's activities and they can act as monitors to top management if they perceive the opportunity to advance into positions held by incompetent executives. On the other hand, outside directors may act as "professional referees" to ensure that competition among insides stimulates actions consistent with shareholder value maximization (Fama, 1980).

Various researchers support the beneficial monitoring and advisory function of outside directors (Brickley & James, 1987; Weisbach 1988; Byrd & Hickmann 1992; Brickley et al. 1994). However, there appears no evidence that insider/outsider ratio is correlated with firm performance (Hermalin & Weisbach, 2001). There appears also no evidence that firms with more independent directors achieve improved firm profitability (Bhagat & Black 2002; Bhagat & Black 1999). Baysinger & Butler (1985) advocate a mix of insiders and outsiders on the board and find empirical support that this approach enhances firm performance. Agrawal & Knoeber (1996) suggests that boards expanded for political reasons often result in too many outsiders on the board, which does not help performance. Carter et al. (2003) find evidence that the proportion of women and minorities on boards decreases when the number of inside directors on boards increases.

Board size

There is a view that larger boards are better for corporate performance because they have a range of expertise to help make better decisions, and are harder for a powerful CEO to dominate. Particularly resource dependence theorists have been the primary foundation for this perspective (Pfeffer, 1972; Pfeffer & Salancik, 1978, Mintzberg, 1983). In this view, board size may be a measure of an organization's ability to form environmental links to secure critical resources (Goodstein et al. 1994). Pfeffer & Salancik (1978) wrote: "The greater the need for effective external linkage, the larger the board should be."

However, recent research has leaned towards smaller boards. Lipton and Losch (1992) and Jensen (1993) were the first to hypothesize that large boards may be less effective than small ones. The underlying notion is that large boards can make coordination, communication, and decision-making more cumbersome than in smaller groups. Smaller boards also reduce the possibility of free riding by, and increase the accountability of, individual directors. Jensen (1993) suggests an optimal board size of seven or eight directors. Yermack (1996) was the first to investigate this proposition theoretically. In fact, using a sample of large U.S. industrial corporations, he reports an inverse relationship between board size and firm value. However, Bhagat and Black (1998) find that the inverse correlation between board size and performance is not robust to the choice of performance measure. Most recently, using a simultaneous equations approach for a sample of Swiss companies Beiner et al. (2003) cannot detect a significant relationship between board size and firm value.

Board committees

Board committees provide a structure for focused non-executive attention to the adequacy and appropriateness of financial controls and risk appraisal, remuneration and incentives, and board composition and succession. To be effective, however, non-executive directors have to develop their knowledge in specialist areas such as audit and remuneration. McNulty et al. (1999) explains that some non-executives express concern over the increasing amount of technical knowledge they had to acquire in order to fulfil their roles on board subcommittees. Further concerns were expressed over the time commitment involved in preparing for, and attending, sub-committee meetings, where agendas often include items of great complexity.

Interlocking directorates

Interlocking directorate occurs when a person from one organization sits on the board of directors of another company and in the most stringent definition, when current senior managers and/or directors of two companies simultaneously serve on each other's board. Interlocking directorates may exist for class integration, defined as the mutual protection of the interests of a social class by its members (Koening & Gogle, 1981). For example, Useem (1982) interviews with 1,307 U.S. And British executives and directors uncover an elite network of directors in various organizations loosely held together by the common goal of preserving their individual and collective positions in society. Another theory that holds interlocking directorates is resource dependence whereby directors could exchange resources, e.g. capital, industry information, and market access, to buffer the effects of environmental uncertainty (Pfeffer & Salanick, 1978). These two different motivations have very different performance implications. Interlocks designed to protect a managerial elite have no a priori implication for firm performance. Those designed to reduce environmental uncertainty could potentially increase the efficient deployment of resources and hence enhance firm performance. There is some evidence, for example, that board interlocks are associated with effective capital acquisitions (Mizruchi & Stearns, 1993).

Multiple board appointments

The issue of multiple board appointments attracts considerable debate. Some shareholder activists criticize multiple board appointments because directors who hold such appointments are ineffective in discharging their function to monitor managers. Several institutions in the U.S. such as the "The Council of Institutional Investors and the National Association of Corporate Directors" generally advocate that directors with full-time jobs should not serve on more than two or three other boards. The Business Roundtable in Washington, DC, by contrast, believes that limits on the number of directors are ill advised. The UK Combined Code suggests that a full time executive director should not take on more than one non-executive directorship in a FTSE 100 company nor the chairmanship of such a company.

Ferris et al. (2003) find no evidence that multiple directors shirk their responsibilities to serve on board committees. He also finds no significant evidence of a relation between multiple directorships and the likelihood that the firm will be named in a security fraud lawsuit.

Frequency of board meeting

Vafes (1999) finds that the annual number of board meetings increases following share price declines and operating performance of firms improves following years of increased board meetings. This suggests meeting frequency is an important dimension of an effective board. Lipton and Lorsch (1992) find that the most widely shared problem directors face is a lack of time to carry out their duties. Conger et al. (1998) find that board-meeting time is an important resource in improving the effectiveness of a board.

Jensen's (1993) opposing view is that board meetings are not necessarily useful because the limited time the outside directors spend together is not used for the meaningful exchange of ideas among themselves or with management. This issue is a by-product of the fact that CEOs almost always set the agenda for board meetings.

Board diversity

Carter et al. (2003) find that there is significant evidence of a positive relationship between board diversity, proxied by the percentage of women and/or minority races on boards, and firm value, measured by Tobin's Q. In a study of Fortune 1000 firms. Adams and Ferreira (2003) find that gender diversity of corporate boards provides directors with more pay-for-performance incentives and that boards meet more frequently. Though not directly looking at board diversity, Keys et al. (2003) present empirical evidence supporting a relationship between diversity promoting activities of firms and expected future cash flows. Specifically, they find filing of discrimination of lawsuits produce a negative and significant stock price reaction.

Notwithstanding above, empirical studies on the relationship between board diversity and firm performance remain spare to date. One explanation is insufficient development of testable theory. Hermalin and Weisbach (2001) comment that board-specific phenomena are not quite explained by principal-agent models and note that current theoretical framework does not provide a clear-cut prediction concerning the link between board diversity and firm value.

On the contrary, institutional investors and shareholder activists have been demanding in recent years that firms appoint directors with different backgrounds and expertise, under the assumption that greater diversity should lead to less insular decision making processes and greater openness to change (Westphal & Milton, 2000).

Literature Review - Part III large literature studies the link between corporate governance and firm's market value or performance. Most of this empirical literature studying the link between corporate governance and firm performance focuses on particular aspects of governance, such as board composition, executive compensation, anti-takeover provisions or shareholder activism. This literature finds strong evidence that board membership is related to the degree of agency problems at firms (Byrd and Hickmann, 1992). However, the evidence for the direct relationship with performance is mixed or goes in an opposite direction from the agency problems. (Bhagat and Black, 1999, Hermalin and Weisbach, 1991).

There is much more limited work that assesses whether overall corporate governance predicts firms' market value or performance. This part of the review provides insight into the recent research on the relationship between a set of corporate-governance provisions and firm's long-term performance, which is the focus of the research proposal.

Black (2001) reports a powerful correlation between the market value and corporate governance of Russian firms. He constructs a firm-specific corporate governance ranking and shows that a one standard deviation change in the corporate governance ranking predicts a seven-fold increase in firm value. However, he has a very small sample size of only 21 firms and does not control for endogeneity.

Durnev and Kim (2002) found that companies with better corporate governance and better disclosure standards tend to have, on average, higher Tobin's Qs and investments. In addition, they report that a 10-point increase (out of 100) in the Credit Lyonnais Securities Asia (CLSA) corporate governance index tends to increase a firm's market value by 13.3%, while a 10-point increase in the S&P disclosure and transparency index increases a firm's market value by 16.3% (Durney and Kim, 2002).

Gompers, Ishii and Metrick's (2003, 2005) study takeover defences for about 1500 U.S. firms. They constructed a corporate-governance index encompassing 24 distinct corporate-governance provisions and studied the relationship between this index and several performance measures. They report evidence that the decile of firms with the strongest takeover defence have lower share prices than the decile with the weakest defences. For this work the results are not so important because in Switzerland hostile takeovers are rare and other aspects of governance are more relevant.

Of much more importance is how they approached their research. Gompers et al. (2003) construction of the governance-index is straightforward: they add one point for every provision that reduces shareholder rights. This index is then used as the central unit of analysis for the rest of their paper. Firms in the highest decile of the index are placed in the "Management Portfolio" and are referred to as having the "highest management power" or the "weakest shareholder rights." Firms in the lowest decile of the index are placed in the "Shareholder Portfolio" and are referred to as having the "lowest management power" or the "strongest shareholder rights."

Drobetz and Schillhofer (2003) analysed the link between corporate governance and firm performance for 91 firms in Germany. They document a positive relationship between governance practices and firm valuation by developing a broad corporate governance rating related to the German Corporate Governance Code. They report that for the median firm a one standard deviation change in the governance rating results in a 24% increase in the value of Tobin's Q.

Zimmermann et al. (2004) addressed the question whether "good" corporate governance has a positive impact on the valuation of listed companies in Switzerland. In order to analyse the hypothesized relationship between the quality of a firm's governance practices and firm valuation they constructed a corporate governance index. The most important result supports the hypothesis of a positive relationship between firm-level corporate governance and Tobin's Q.

Unfortunately, empirical studies on corporate governance have more than the usual share of econometric problems (Koke and Brsch-Supran, 2000).The named studies do not directly address the possible endogeneity of corporate governance mechanisms, i.e. most of the results just described can only be interpreted as partial correlation without clear indication of causality.

An exception is Black, Jang and Kim (2003) who find a positive relation between their corporate governance index and Tobin's Q. For a sample of 526 Korean public companies. Their index is primarily based on responses to a survey among Korean listed companies. It consists of six sub-indices for shareholder rights, boards of directors, outside directors, audit committee and internal auditor, disclosure to investors and ownership parity. To control for a possible endogeneity, they use a three stage least square (3SLS) simultaneous equation approach and show that a 10 point increase causes a 19.4 increase in Tobin's Q.

Black et a. (2003, p. 12) write "A recurring issue in studies of firm-level corporate governance is the potential for results to be explained by quality signalling, by reverse causation.." Quality signalling means that firm signal high quality by adopting good governance rules, but it is the signal, not the governance rules, that affects firm value. For the purpose of this study this quality signalling is no issue because the analysis is whether the board's decision on corporate governance affects firm value. Therefore, it is irrelevant whether the governance rule adapted or the signalling effect impacts firm value. The important thing is that a decision of the board impacts firm value. Reverse causation is explained by Black et al. (2003, p. 12) "In the reverse causation flavour of endogeneity, firms with high Tobin's Q. choose good governance rules (presumably because this further enhances their market values). There will then be a causal connection between governance and firm value." For the purpose of this study exactly the same as for the signalling affect holds. The decision of the board to affect firm value by a decision to increase governance is the important point. As it is difficult in most cases to draw causal inferences, this study makes no claims about the direction of causality between governance and performance.

Regulatory development

This section provides an overview over the recent regulatory developments. The review demonstrates that regulators are concerned with structure and responsibilities of boards of directors. The aim of this section is to show that regulators are advocating that boards should be composed by a majority of outside independent directors despite the existence of mixed empirical evidence as outlined in the previous chapters.

Overview

Given the undisputed leadership role played by American developments and, since publication of the Cadbury Report, also by the debate in the UK on corporate governance (Hofstetter, 2001), it seems appropriate to make primarily reference to these Anglo-Saxon benchmarks.

In the U.S. The discussion of corporate governance became particularly lively in the 1980s and 1990s. This debate was triggered, in particular, by a proposal by the American Law Institute. The Securities and Exchange Commission (SEC) and the New York Stock Exchange (NYSE) also took up the matter, leading ultimately to the Blue Ribbon Report on the independence of the audit function and on the audit committee in 1999. However, no actual corporate governance guideline exists in the U.S. In the sense of an official or unofficial summary of best practices. Following the corporate governance scandals in the U.S., the Sarbanes Oaxley Act (SOA) was enacted in 2002. The SOA covers matters including the establishment of audit committees, disclosure committees, and codes of ethics, with an emphasis upon the disclosure of information and transparency. It describes, for example, the principle of vicinity of insolvency and the relevant information to be disclosed to shareholders and creditors. The issue of directors' duties and responsibilities is addressed, together with the consequences of insider trading and conflicts of interests. The act also contains provisions on whistleblowers and introduces new criminal sanctions for company wrongdoings, as well as enhancing the penalties already in place.

Great Britain took a different route. It all began with the Cadbury Report of 1992, which was later supplemented by the Greenbury Report of 1995, the Hampel Report of 1998 and finally the Combined Code of 1998. The Cadbury Committee was set up in May 1991 by the Financial Reporting Council, the London Stock Exchange and the accountancy profession to address the financial aspects of corporate governance. The report mainly reviewed the structure and responsibilities of boards of directors, rights and responsibilities of shareholders and the role of auditors. The Hampel Committee was constituted in the UK in 1995. The task of this committee was to consolidate the recommendations of the Cadbury Report in 1992 (focusing on financial reporting) and the Greenbury Report in 1995 (focusing on directors' remuneration), and prepare a Combined Code on corporate governance. The Code, published in 1998, was attached to the listing rules of the stock exchange with the requirement that in order to be listed, companies must either declare their adherence to its provisions or explain any deviation from them (comply or explain principle). In September 1999 a report on "Internal Control," known as the Turnbull Report, which required the Board of Directors to confirm that there was an on-going process for identifying, evaluating and managing the key business risks, was drafted. In 2003, after a review of the role and effectiveness of non-executive directors by Derek Higgs and a review of audit committees by a group led by Sir Robert Smith, a new "Combined Code" was issued.

The Anglo-Saxon trend spread to other countries and led for example to the Vienot Report of 1995 in France (superseded in 2003 after the Bouton Report) and to the adoption of corporate governance principles of the OECD in 1999 (revised 2004). The key changes are (OECD, 2004):

greater emphasis on transparency and directors responsibility through improved related party transactions disclosure and whistle-blower protections;

auditors being made explicitly accountable to shareholders;

new principles on shareholders access to information and ability to influence the board membership and remuneration commensurate with their voting share;

Finally, it also influenced events in Germany, primarily in the framework of the law on control and transparency in corporate matters of 1998 (KonTraG) and later with the adoption of corporate governance principles by the Federation of German industry, the Berlin Initiative Group and more recently the Government Commission on the German corporate governance Code (revised 2003). Over the last years many other European countries have adopted national corporate governance codes. For example, the Transparency Act in Spain aims at further strengthening corporate governance by establishing additional requirements in cases of director's conflict of interest among others. The Dutch Code of Best Practice gives clear guidance on the number of independent supervisory directors, stating that all but one member of the supervisory board should be independent.

The case of Switzerland

According to Bckli (2000) Switzerland is heavily coloured by the U.S. And UK corporate governance development. Companies in Switzerland have been faced with increasing regulations and expectations regarding their corporate governance practice. Increasingly, such regulations and expectations are not just applicable in the country of residence. Swiss companies with significant operations in the United States, for example, are confronted with enhanced expectations from their customers, suppliers or investors in those countries. In order to remain competitive, there is an inevitable trend that Switzerland has to adopt its corporate governance regulations to the more rigid system of the U.S.

Bckli (2000) mentioned that the first step to improve transparency of Swiss companies was the adoption of the new Stock Corporation Law by the Federal Parliament in 1991, which is the core of corporate governance rules in Switzerland. For example, the possibility for the board of directors to refuse buyers of registered shares (Vinkulierung) without mentioning a reason has been abolished; the proxy voting systems by banks has been regulated. On the other hand, the often-criticised "anti-foreigner clause," which allows the board to refuse any foreigner as shareholder could not be abolished. The new law brought some improvements concerning accounting rules. For example, the creation and dissolution of hidden reserves became for the first time subject to legal constraints. The most important change in financial market regulation was the adoption of a Federal Stock Exchange Law in 1995. The regulation of takeover bids was one of the most important pieces of the new law.

The analytical study by Hofstetter (2002) on corporate governance in Switzerland was the starting point of the Swiss Code. Hofstetter (2002, p. 1) wrote

As the work proceeded, it soon became apparent that the national and international market environment had created the need for a study of the existing situation of corporate governance in Switzerland and action for the adoption of best practice recommendations that take account of the special circumstances of the Swiss corporate landscape."

Under the umbrella of the Swiss Business Federation rules on corporate behaviour and non-binding checks and balances were developed. These rules were adopted as the Swiss Code of Best Practice (the Code) that has been in effect since July 1, 2002. The Code works in conjunction with the Swiss stock exchanges set of rules on transparency for compensations, shareholdings and other participations of senior management (Directive on Corporate Governance, Directive on Directors Dealing).

Recent developments show a trend towards strict law and regulatory intervention, and against non-binding recommendations and a self-regulatory approach to issues of corporate governance. This is illustrated by three legislative projects published in June 2004 that are likely to have far-reaching effects on corporate governance practice in Switzerland. They are:

the draft amendment of the Swiss Code of Obligations on the disclosure of the remuneration of board members and senior management;

the draft amendment of the Swiss Code of Obligations on statutory audit rules; and the draft amendment on the admission and supervision of auditors.

Conclusion

In general, there is a trend to shift power from the inside to the outside of an organization.

The initiatives of the regulators aim at the separation of the roles of the CEO and the chair of the board, the introduction of non-executive lead directors to boards when these roles are put in the hands of one individual, the appointment of an increasing number of non-executive directors to corporate boards who have not been affiliated with the firm and the formation of independent oversight board committees composed predominantly of non-executive directors. These reform initiatives suggest that boardroom reformers increasingly advocate design strategies that facilitate the separation of decision management from decision control in one-tier boards (Massen, 1999).

For example, the Cadbury report in the UK, the Blue Ribbon Committee in the U.S. And the Swiss Code of Best Practice recommend that the audit committee should exclusively consist of independent directors. On November 2003, the U.S. Securities and Exchange Commission (SEC) approved a listing proposal of the New York Stock Exchange and the Nasdaq Stock Market requiring widespread strengthening of corporate governance standards for listed companies. The new rules establish a stricter, more detailed definition of independence for directors and require the majority of members on listed companies' boards to satisfy that standard (SEC http:/www.sec.gov/news/press2003-150.htm).

The above-mentioned development is also illustrated comparing the Cadbury Report of 1992 with the Combined Code on Corporate Governance of 2003 where the movements toward independence of the board can be seen:

Table 2: Recommendations of the Independence of Corporate Boards (column "Cadbury Report" based on Massen, 1999)

Governance Issue

Cadbury Report, 1992

Combined Code on Corporate

Governance, 2003

CEO and Chairman separation recommended but not compulsory the role of chairman and CEO should not be exercised by the same individual; no individual should be appointed to a second chairmanship of a FTSE 100 company

Lead director there should be a strong and independent element on the board with a recognized senior member the board should appoint one of the independent non-executive directors to be the senior independent director

Non-executive directors minimum of three non-executive directors

At least half of the board, excluding the chairman, should be non-executive directors; smaller companies should have at least two in-dependent directors

Independence of directors majority of non-executives should be independent the above mentioned non-executive directors should be independent; the board should identify in the annual report each non-executive it considers to be independent

Nomination of directors should be appointed through formal board process via nomination committees dominated by non-executive directors should be appointed through formal board process via nomination committees dominated by independent non-executive directors;

Independence of the auditor audit committee of the board should be formed, comprised exclusively of non-executive directors

Audit committee of the board should be formed, comprised of at least three independent non-executive directors (smaller companies: two) whereas at least one member has recent and relevant financial experience

Objectives of the proposed research

Hitherto, the discussion about corporate governance, in particular, the board of directors, and the regulatory development within the framework has shown that the pressure towards board reforms is not entirely embedded in empirical evidence.

For example, the research literature is replete with contradictory findings about whether, for example, outside independent directors promote shareholders interests better than inside directors. Real world experience shows that although independent directors dominate, for example, the board of directors of U.S. public companies (Bhagat and Black, 1999), there are numerous examples where highly independent boards have not prevented large-scale wealth destruction. One of the most recent examples is Enron (with eleven independent outside directors on its fourteen-member board). However, regulators are advocating that a majority of outside independent directors should compose boards.

One problem of the previous research is that it has generally focused on examining subsets of governance mechanisms, typically studying one or two governance variables in any one study (Bhagat & Black, 1999; Danielson and Karpoff, 1998). This view is supported by several researchers (Redliker & Seth, 1995; Baysinger & Hoskisson, 1990). Agrawal and Knoeber (1996) argue that the extent to which alternative control mechanisms are used is decided within the firm.