G9 - Bogac Kanadli - OfEL 2014

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Board Composition: Effectiveness of Decision Control Role under Perceived Uncertainty

Sadi Boğaç Kanadlı

ESADE Universitat Ramon Llull, Barcelona, Spain

[email protected]

Abstract

According to agency theory (AT) boards are internal governance mechanisms which can

reduce agency costs and improve a firm’s performance through performing effective decision

control role on strategic decisions. Board effectiveness is determined by board independence

which requires boards to be comprised of greater proportions of outside directors as they are

assumed to perform decision control role more objectively than the insiders. However, under

perceived environmental uncertainty (located outside the firm) strategic decisions are

blended with CEOs’ judgment which may not be controlled objectively, due to measurement

and evaluation issues. Thus, effective decision control may require boards to be comprised of

directors’ who can share, read and evaluate a CEO’s judgment. In this context, while AT

suggestions on effective boards and best practices of board composition built on AT logic may

benefit firms facing uncertainty due to information asymmetries (located inside the firm),

those suggestions and practices may be limited particularly for the firms operating under

outside-firm uncertainty. Decomposing decision control role into evaluation and monitoring

tasks, we derive propositions on board composition under each type of uncertainty for future

research. Our study contributes to the literature by introducing a model of the relationship

between board composition and uncertainty in the agency context. Particularly, scholars

existing knowledge about factors that may affect board composition and board effectiveness,

is enriched. Our research, to be empirically tested, invites policy makers, as well as influence

groups such as institutional investors to reconsider best practices of board composition rested

on AT logic.

Keywords: Agency Theory, Board composition, Decision control role, Managerial Judgment,

Uncertainty, Trust,

1. Introduction

Today, together with CEOs, boards are held responsible for firms’ success or failure and from

being “rubber stamps”, boards have evolved into active and independent monitors,

participating strategy formulation through evaluating and monitoring strategic decisions

(MacAvoy and Millstein, 1999; Rindova, 1999; Westphal, 1999; Hendry and Kiel, 2004).

Independent boards’ active involvement in strategy formulation through implementing

decision control role on strategic decisions is rooted in agency theory (AT) (Jensen and

Meckling, 1976; Fama and Jensen, 1983). According to this dominant paradigm used in board

research (Dalton et al., 1998; Daily et al., 2003), effective boards are comprised of greater

proportion of independent directors, outside directors who are not current or past employees

and who do not have substantial business or family ties with management (Johnson et al.,

1996), who can evaluate managerial decisions more objectively than inside directors (Kosnik,

1987; Westphal, 1999).

Strategic decisions have critical impacts on an organization’s survival and health and

perceived environmental uncertainty (hereafter perceived uncertainty) is a fundamental

problem with which CEOs must cope with in strategic decision making (Duncan, 1972;

Milliken, 1987; Eisenhardt, 1989). Perceived uncertainty is specified as the uncertainty that a

Proceedings of the 2nd

International OFEL Conference on Governance, Management and Entrepreneurship, 4th

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April, 2014, Dubrovnik, Croatia

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CEO may face due to lack of information about the state of organizational environment or a

component of that environment and his/her inability to assign probabilities to outcome of

events (Duncan, 1972; Milliken, 1987). In this regard, rational choice process (gather

information, generate options, weigh these up, implement the one that maximizes utility) that

is incorporated in AT may not generate final decision choices that can be evaluated

objectively. Because, under perceived uncertainty final decision choice incorporates a CEO’s

subjective evaluation of the events (Knight, 1921) and/or confidence in evaluating those

events (Duncan, 1972) and/or managerial intuition (Bourgeois and Eisenhardt, 1988).

Therefore, under uncertainty strategic decisions are blended with managerial judgment which

is different than analysis that relies on data and set of preconceived benchmarks that are used

for comparison (Brownlie and Spender, 1995; Shapira, 2000).

The purpose of this study is to answer the question of how effective decision control can be

implemented on strategic decisions made under perceived environmental uncertainty. Under

uncertainty lack of objectivity may cause long discussions and evaluations in the boardroom

that may paralyze strategic decision making because board members demand justifications

and explanations for proposed strategic decisions (Macdonald et al., 2008). Thus, uncertainty

may have an impact on corporate governance by creating measurement and evaluation issues

which turns uncertainty into an important concern also for boards which are required to

implement effective decision control role.

The construct of uncertainty embedded in AT framework, is a heritage from principal-agent

theory of the firm (PAT) (Ross, 1973; Jensen and Meckling 1976) which is used as a stepping

off point by AT (Donaldson, 2012). Different than AT focus on managerial decisions,

monitoring managers’ effort and effort type is the focus in PAT (Eisenhardt, 1989).

Information asymmetry that gives rise to adverse selection and moral hazard issues is the

source of uncertainty embedded in PAT which is located inside the firm. In this perspective,

PAT suggests monitoring mechanisms, such as board of directors, to reduce uncertainty,

information asymmetry, about the agents’ (CEOs) effort and effort type (Eisenhardt, 1989;

Nilakant and Rao, 1993). Scholars mention the lack of work that explores variation in board

process and director effectiveness in different organizational contexts (Pye and Pettigrew,

2005) but still, to the best of our knowledge the effectiveness of boards in implementing

decision control role under uncertain environments has not been explored yet.

Zahra and Pearce (1989) state the importance of specifying the factors that affect board

composition in details as board composition may have direct or indirect effect on board

effectiveness which affects firm performance. We extend this insightful suggestion by stating

also the importance of operationalizing of different tasks comprising a board role. In this

regard, we not only distinguish in-firm uncertainty from outside-firm uncertainty as factors

affecting board composition but also decompose decision control role into evaluation task,

ratifying managerial decisions, and monitoring task, monitoring CEO’s actions and

implementation of decisions.

Using the insights we gather from theories of managerial judgment and trust, we argue that

under perceived uncertainty effective evaluation task will require collaboration between a

CEO and directors where directors may actively participate in decision making and

experience the situations that call for CEO’s judgment. Thus, first set of propositions

highlight the contribution of inside directors on board effectiveness under perceived

uncertainty. In addition, due to its positive effect on collaboration (Kramer, 1999; Westphal

1999; Hillman and Dalziel, 2003; Shen, 2003) we suggest interpersonal trust between the

CEO and the directors will moderate the positive impact of collaboration on board



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effectiveness. Lastly, we propose the impact of board independence on board effectiveness

will depend on the type of uncertainty that a firm will face.

We made two contributions to the literature. First, this study answers scholars’ call in

determining the factors that affect board composition, specifying these factors in details and

enriching fundamental issues of governance by using alternative theories (Zahra and Pearce,

1989; Daily et al., 2003; Hermalin and Weisbach, 2003). Second, present study introduces a

model of the relationship between board composition and uncertainty in AT framework. Our

research, to be empirically tested, invites policy makers, as well as influence groups such as

institutional investors to reconsider best practices of board composition rested on AT logic.

2. Theory

2. 1. Agency Theory: Board Decision Control Role

Today, together with CEOs, boards are held responsible for firms’ success or failure

(Rindova, 1999; Hendry and Kiel, 2004). From being “rubber stamps”, boards have evolved

into active and independent monitors (MacAvoy and Millstein, 1999) and independent

boards’ active involvement in strategy formulation is rooted in AT which has become the

dominant theoretical perspective used on board research (Dalton et al., 1998; Daily et al.,

2003; Hillman and Dalziel, 2003). According to AT, boards’ active involvement in corporate

governance is achieved through performing effective decision control role on important

managerial (strategic) decisions (Fama and Jensen, 1983). Fama and Jensen (1983) specify

decision control as the main role of a board where members of the board (directors) ratify and

monitor strategic decisions. Ratifying is further specified as the evaluation of a CEO’s final

decision choice to make sure the decision outcomes are aligned with shareholders’ interest

whereas monitoring is defined as the monitoring of a CEO’s actions and implementation of

the decision made (Fama and Jensen, 1983; Westphal, 1999).

Scholars acknowledge the importance of knowing the factors that affect board composition is

clearly an important step in understanding boards and their role. In addition, board

composition, board size and mix of director types, has been stated as the most critical board

attribute that may affect board effectiveness in performing board roles which may affect a

firm’s performance (Pearce and Zahra 1989; Hermalin and Weisbach 1988). In this regard,

AT argues boards to be comprised of greater proportion of outside directors for an effective

decision control role which can reduce agency costs and thus enhance a firm’s performance.

(Westphal 1999; Hillman and Dalziel 2003).

Board effectiveness in implementing decision control role

According to AT outside directors are critical to the board's ability to exercise decision

control, because as non-employee directors they are formally independent from management

and thus better able to evaluate management decisions objectively on behalf of shareholders'

interests. (Westphal, 1999; Gulati and Westphal 1999). In this regard, agency theorists

acknowledge that directors and boards vary in their incentives to evaluate managerial

decisions and board dependence, as a board incentive, determine the board effectiveness in

performing control role (Hillman and Dalziel 2003). Thus, a key hypothesis of AT argues that

effective boards are required to be comprised of greater proportions of independent directors,

who are not current or past employees and who do not have substantial business or family ties

with management (Johnson et al., 1996), as they can control managerial decisions more

objectively than inside directors.



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AT’s independent-boards hypothesis has turned into a dominant perspective in literature and

practice (Zahra and Pearce, 1989; Dalton et al. 1998; Bhagat and Black, 1999; Westpal, 1999;

Boone et al. 2007) although the link between board independence – firm performance has yet

to be unequivocally supported (Dalton et al., 1998). Bahagat and Black (1999) states the trend

in practice that requires “substantial majority” of outside directors on boards and even an

“ideal board” composition where only the CEO is an insider. Acknowledging the close link

between governance theory and practice, independent boards trend need to be reconsidered.

To understand boards and their role in corporate governance, research on boards needs to be

enriched by exploring new factors that affect board composition (Hermalin and Weisbach,

2003), specifying these factors in details (Zahra and Pearce, 1989) and using alternative

theories in explaining the link within (Daily et al., 2003).

With the same logic, detailed specification of roles can be another important step in exploring

the effect of factors, specified in details, on board composition and board effectiveness in

performing board roles. AT decision control role can be specified to be composed of two

tasks where directors’ ratify strategic decisions (evaluation task) and monitor a CEO’s actions

and implementation of the decision made (monitoring task). For example, Zahra and Pearce

(1989) state one limitation of AT as its focus on decision outcomes rather than the decision

making process where the authors are referring to the evaluation task and criticizing the

evaluation of outcomes of a strategic decision rather than the formulation process.

In this perspective, next part specify the construct of uncertainty adopted in AT which is a

heritage from principal-agent theory of the firm (PAT) (Ross, 1973; Jensen and Meckling,

1976) that is used as a stepping-off point by AT (Donaldson, 2012). This specification

provides a better understanding about the key AT hypothesis, the importance of

differentiating in-firm uncertainty from outside-firm uncertainty and the decomposition of

decision control role into evaluation and monitoring tasks. AT independent-boards hypothesis

is a natural reflection of a PAT heritage that explains the alternative use of monitoring

mechanisms (board of directors) to reduce in-firm uncertainty (information asymmetry) about

the agents (CEOs) effort and effort type. Thus, effective monitoring depends on directors’

objective controls on CEOs’ actions and implication of decisions that maximize principals’

profit.

2.2 PAT Heritage and AT’s Independent Boards Hypothesis

AT governance model uses principal-agent ToF as a stepping off point (Donaldson 2012). It is

important to acknowledge this transmission because principal-agent ToF proposes the use of

the two governance mechanisms, incentive and monitoring, to reduce uncertainty about the

CEOs’ effort and effort type so that managerial opportunism can be controlled (Nilikant and

Rao, 1993). After Fama and Jensen’s (1983) seminal study the focus of AT has shifted from

controlling agents’ effort and effort type to ratifying CEOs important managerial decisions

where both evaluation and monitoring tasks are combined under the board role of “decision

control”.

PAT: Governance Mechanisms under Uncertainty Located Inside a Firm

In PAT, information asymmetry, principals’ lack of information about the top manager´s

effort and type of effort, is the source of uncertainty (Akerlof 1970), that should be minimized

through different governance mechanisms to limit the opportunistic behavior of managers

(Eisenhardt, 1989). Research specifies three factors associated with uncertainty in PAT as

moral hazard, where the agent may expend less than optimal effort, adverse selection, where



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the agent may expend an inappropriate type of effort, and the state of nature, which is outside

the control of both the principal and the agent (Eisenhardt, 1989; Nilakant and Rao, 1993).

Dosi and Egidi (1991) identify two different types of uncertainty as substantive and

procedural uncertainty. Dosi and Egidi (1991) claim substantive uncertainty results from the

lack of all the information which would be necessary to make decisions with certain

outcomes; in contrast, procedural uncertainty arises from limitations on the computational and

cognitive capabilities of the agents to pursue unambiguously their objectives, given the

available information. In this context, the uncertainty embedded in agency theory is related

with the principals’ computational and cognitive capabilities that limit the information about

agents’ effort and effort type. Under this limitation principals face with the problems of

adverse selection and moral hazard both of which negatively affect principals’ objective of

profit maximization. Therefore, under uncertainty PAT suggest the use of monitoring

mechanisms, boards, that will enrich the principals’ information on agents effort and effort

type. The type of uncertainty embedded in PAT, can be specified as procedural uncertainty

rising inside the firm which is aimed to be reduced by monitoring mechanisms (Eisenhardt,

1989; Velamuri and Venkataraman, 2005).

It is important to note that PAT adopts an implicit assumption of, untrustworthy but heroic

managers because this view of top managers also explains the rationale behind the AT

independent-board hypothesis. According to PAT, heroic managers, rational actors, are

capable of ranking decision alternatives from most preferred to least preferred (Albenese et

al., 1997). These alternatives include both the decision that maximizes manager’s utility and

the one maximizes principals’. Thus, managers should be motivated ex-ante with incentive

mechanisms to persuade them simply to choose the one that benefit shareholders’ interest. If

there is uncertainty about managers’ effort (moral hazard) or effort type (adverse selection)

due to information asymmetry and incentive mechanisms become ineffective, managerial

actions and decisions should be monitored (e.g by board of directors). The implementation of

monitoring by boards or external auditors or any other controller implies that decisions are

ranked objectively, in terms of calculable values, so that controllers can review, evaluated and

decide to/not to ratify the CEO’s final decision choice.

In other words, managers are capable of specifying the clear probabilities of outcome of every

event for each decision alternative, and ranking them with monetary values assigned as it is

the case in a cost-benefit analysis, so that representatives of principals can simply evaluate the

managers’ analysis and ratify that specific decision only if principals’ interests are preserved.

Acknowledging this implicit assumption about heroic managers who can assign probabilities

objectively is important because AT’s independent-boards hypothesis rests on evaluations of

these final decision choices by directors. PAT framework is used by AT as a stepping off

point in this context. Since a CEO’s final decision choice can be expressed in concrete

monetary values all directors can simply evaluate her/his analysis.

Therefore, according to AT the board composition is a reflection of the requirement of

selecting directors who can be objective in their evaluations. Hence, AT perspective, having

the PAT heritage and without making a distinction between evaluation and monitoring tasks,

explore the main question of “Who can be more objective?” rather than “Who can be more

competent in controlling strategic decisions?”.

On the other hand, under perceived uncertainty final decision choice depends on CEO’s

subjective evaluation of the events (Knight, 1921) and/or her/his confidence in evaluating

those events (Duncan, 1972). In other words, under uncertainty strategic decisions are blended



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with managerial judgment which is different than analysis that relies on data and set of

preconceived benchmarks that are used for comparison (Brownlie and Spender, 1995;

Shapira, 2000). Hence, AT arguments and best practices of board composition built on agency

logic may be limited as uncertainty may cause measurement and evaluation issues (Carson et

al., 2006), that challenge particularly effectiveness of independent boards in implementing

evaluation task. Independent directors’ efforts in implementation of objective evaluations may

cause long evaluations and discussions in the boardroom, due to measurement and evaluation

issues, as directors demand justifications and explanations for proposed strategic decisions

(Macdonald et al., 2008).

2.3 Effective decision control under perceived uncertainty

Decision making can be defined as the gathering and processing of information that proceeds

to an actual decision choice and uncertainty is a fundamental problem with which CEOs must

cope with in decision making (Duncan, 1972). Strategic decisions, which are important, in

terms of the actions taken, the resources committed or the precedents set have critical impacts

on an organization’s survival and health and these decisions are mostly CEO dominated under

perceived uncertainty (Eisenhardt, 1989; Bourgeois and Eisenhardt, 1988). Milliken (1987)

defines perceived uncertainty as the CEOs uncertainty about the probability or nature of the

changes take place in perceived organizational environment or a component of that

environment. Duncan (1972) states the lack of information and CEOs’ inability to assign

probabilities to the outcome of events as the main components of perceived uncertainty.

Inability of assigning probabilities affects the classification of decision alternatives

objectively which is needed to rank alternatives so that an evaluation criterion (e.g

shareholders’ profit maximization in AT) can be applied to make a decision (Langlois and

Cosgel 1993, Denzau and North 1994).

In uncertain environments where CEOs experience perceived uncertainty, such as high

velocity environments, environments that have high levels of environmental dynamism,

needed information may become scarce and even unavailable (Eisenhardt, 1989; Bourgeois

and Eisenhardt, 1988; Duncan, 1972; Milliken, 1990). CEOs may be forced to make strategic

decisions with limited amount of information which may not be sufficient to determine the

probabilities of outcome of events objectively. This inability is fulfilled by CEO’s subjective

evaluation (Knight, 1921) of the events attached to each decision choice and/or CEO’s

confidence in his/her evaluations (Duncan, 1972). In this regard, a strategic decision may

greatly depend on a CEO’s managerial judgment under perceived uncertainty (see Table 1)

(Brownlie and Spender, 1995; Shapira, 2000) which may not be justified objectively as it can

be done in a cost-benefit analysis.

Uncertainty requires managerial judgment Douglas Brownlie and Jason Christopher Spender

(1995: 40) say “Uncertainty is resolved by an act of managerial judgment. Judgment is what

the decision maker adds to cope with the uncertainty which exists in the situation he/she

confronts. And the situation itself is an interpretation, or a reading of ambiguous

circumstances which is socially constructed or negotiated.”. It is important to note that

managerial judgment is different than analysis that relies on data and set of preconceived

benchmarks that are used for comparison (Brownlie and Spender 1995). It is important

because under uncertainty a CEO’s ranking alternative decision choices may rely on her/his

subject evaluation or confidence which may cause measurement and evaluation issues. In this

regard, effective implementation of evaluation task may require directors who can share, read

and evaluate CEOs’ managerial judgment embedded in strategic decision choice.



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Decision control under uncertainty requires collaboration Managerial judgment will be

gained through experiencing situations that call for judgment (Brownlie and Spender 1995).

Thus, to share, read and be able to evaluate managerial judgment, together with the CEO,

directors need to actively get involved in decision making processes, experience situations

that call for judgment. Thus, evaluation of strategic decisions blended with managerial

judgment requires collaboration between the CEO and the directors. Many studies

recommend a collaborative model of boards but mostly because these studies use multiple

theoretical perspectives that suggest different board roles in addition to decision control role

(e.g. Gulati and Westphal 1999; Rindova, 1999; Westphal, 1999; Hillman and Dalziel, 2003;

Sundaramurthy and Lewis, 2003).

Table 1: Decision control on strategic decisions

CEO Decision making Decision Control

Requirements Information

gathering

Information processing

Information Measurement, evaluation

issues

AT perspective Available No Objective

evaluation of

analysis

Under perceived

uncertainty

Limited, scarce Inability to assign

probabilities to outcome

of events

Evaluation of

managerial

judgment

Still, when only AT perspective is adopted and effectiveness of board decision control role is

explored under perceived uncertainty, collaboration between the CEO and the directors is

required. Directors’ active involvement in strategic decision making can help directors to

better perform decision control functions as they may understand in depth the process and this

collaboration may provide opportunities to exchange experiences and judgment between the

CEO and directors (Andrews, 1981). Although AT places little emphasis on trust (Whitener et

al., 1998: 514), forming trusting relations between the CEO and the directors becomes critical

under perceived uncertainty, as trust enhances collaboration.

Trust enhance collaboration Trust requires uncertainty because "if one were omniscient,

actions could be undertaken with complete certainty, leaving no need, or even possibility, for

trust to develop" (Lewis and Weigert, 1985: 970). Trust is seen as an attitude held by one

individual – trustor- to an another –trustee- and this attitude is derived from the trustor’s

perceptions, beliefs and attributions about the trustee, based upon his or her observations of

the trustee’s behavior (Robinson,1996; Whitener et al., 1998). In this regard, trustor’s, CEO’s,

perceptions of the trustee’s, director’s, competence, benevolence and integrity appear to be

the critical conditions for trust (Mayer et al., 1995). Formal or informal ties where the CEO

may share a common history with the directors enable the observation of required conditions.

Shapira (2000) states the importance of the memory of the past behavior in forming trusting

relations. Moreover, Kramer (1999) states the research on trust development has shown

building trusting relationships is largely history-dependent processes.

Trust in the boardroom is expected to stimulate cohesiveness, openness and generosity as well

as creativity and involvement, teamwork and cooperative behavior (Kramer, 1999; Westphal



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1999; Hillman and Dalziel, 2003; Shen, 2003). Moreover, Balau (1964) and Deutsch (1958)

consider trust fundamental to cooperative relationships (cf. Whitener et al., 1998). Due to

trust, boards’ involvement in strategic decision making may be enhanced as the CEO may feel

comfortable in setting a collaborative ground (Melcher, 1996). Westphal (1999) explains how

social ties, friendship between the CEO and the directors, imply mutual trust, and accordingly

how trust promotes collaboration in the boardroom and the boards’ effectiveness in involving

strategic decisions. In this perspective, developing trusting relationships between a CEO and

the directors may stimulate the link between collaboration and effectiveness of boards in

implementing evaluation task under perceived uncertainty.

3. Propositions: Effective boards under uncertainty

Traditionally, outside or inside directors are selected to boards which are required to evaluate

and monitor strategic decisions. Baysinger and Butler (1985) suggested that outside directors

primarily exercise control and inside directors are the main source of advice on strategic

issues. But, Andrews (1981) states that, outside directors may not be well enough informed

about the intricacies of the firm’s business to review and evaluate strategic recommendations

and they may be unwilling to become involved in making long-term decisions characterized

by risk and uncertainty. In addition to these information and commitment problems, due to

time constraints outside directors may fail to incorporate into decision making process

(Lorsch and Maclver, 1989; Finkelstein and Hambrick, 1996), and, together with the CEO,

experience situations that call for judgment.

Baysinger and Hoskisson (1990: 74) highlights the comparative disadvantage of outside

directors to insiders in evaluating decision making through open and subjective evaluation

processes which will help directors to share and read CEO’s judgment. Outside directors may

prefer to maintain an open and subjective relationship with top management, but they simply

may lack the amount and quality of information which can be gathered through participating

decision making processes.

On the other hand, inside directors who have firm specific and specialized knowledge

(Anderson and Reep, 2004; Fama and Jensen 1983) do participate in decision making process

(Baysinger and Hoskisson 1990) and consequently they are more likely to experience

situations that call for judgment. CEOs share their burdens (e.g. lack of information) with

inside directors to help share their judgments (Brownlie and Spender, 1995) and inside

directors’ involvement in decision making help them to share their experiences and judgment

with the CEO. Due to this collaboration inside directors develop a deeper understanding of the

firm’s strategy which enable inside directors to evaluate strategic decisions through open and

subjective evaluation processes which helps them to read and share CEO’s judgment.

Proposition 1a: Inside directors will enhance board effectiveness in implementing decision

control role under perceived uncertainty by promoting effectiveness of evaluation task.

On the other hand, under in-firm uncertainty boards’ monitoring task may become essential to

mitigate potential agency problems. Thus, principals will be willing to have a board

comprised of independent directors who can facilitate objectivity (Kosnik, 1987) and reduce

information asymmetry by monitoring CEOs actions and the implementation of strategic

decisions made. Independent directors will have substantial incentive and motivation to

monitor CEOs because they focus on financial performance, which is a central component of

monitoring, they are more likely than insiders to dismiss CEOs following poor performance



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and protecting their personal reputations as effective controllers (Finkelstein S, D'aveni,

1994).

Proposition 1b: Outside directors will enhance board effectiveness in implementing decision

control role under uncertainty that is due information asymmetry, by promoting effectiveness

of monitoring task.

As noted, the recent trend in practice requires supermajority-independent boards where the

number of insiders is limited to one or two and even an “ideal board” composition where only

the CEO is an insider (Bahagat and Black, 1999). Alternatively, following propositions 1a and

1b, we recommend:

Proposition 1c: A mix of inside and outside directors will enhance board effectiveness in

implementing decision control role on strategic decisions when a firm faces both in-firm and

outside-firm uncertainty.

AT perspective inhibits the development of trusting relations (Whitener et al., 1998) whereas

building and maintaining trust in the boardroom is also an important requirement for effective

monitoring (Forbes and Milliken, 1999; Daily et al., 2003). As noted, trust may enhance

collaboration by stimulating cohesiveness, openness and generosity as well as creativity and

involvement, teamwork, cooperative behaviors, relationships and trust enhance collaboration

in the boardroom and promote board’s involvement in strategy formulation. In this

perspective, trust stimulates the collaboration between a CEO and a director which further

help inside directors to actively participate in decision making process, experience situations

that call for judgment and exchange experiences and judgment through open and subjective

evaluation processes. Thus, we propose:

Preposition 2a: Interpersonal trust will moderate the positive impact of inside directors on

board effectiveness under perceived uncertainty. The inside directors-board effectiveness

relationship will be enhanced under conditions of trust as trust promote collaboration.

On the other hand, monitoring CEOs’ actions and implementation of managerial decisions,

will require some distance so that effective monitoring can be achieved (Daily et al., 2003;

Sundaramurthy and Lewis, 2003). Effective monitoring under uncertainty when the

uncertainty is related with information asymmetry will rest on directors’ objective control of

managerial actions and steps taken in the post decision implementation period to preserve

shareholders’ interest (Fama and Jensen, 1983).

Preposition 2b: Interpersonal trust between the CEO and directors will have no effect on

board effectiveness in monitoring strategic decisions made under uncertainty when

uncertainty is due to information asymmetry.

As noted, integrity is a critical factor determining the foundation of trust and the important

essence of integrity is the consistency in behaviors that can be observed (Mayer et al. 1995).

Outside independent directors are mostly top managers of other organizations who may lack

firm specific information, time and interest for involving in the decision making processes.

Rather, outside directors are expected to attain the board meetings in specified period, review

and evaluate managerial decisions and CEO performance. In this perspective, the common

history that is required to be shared for the observation of directors’ consistency by the CEO

will be limited with these periodical meetings.

Accordingly, board independence which requires a board to be dominated by outside

directors, may limit the development of trusting relationships in the boardroom. In addition,



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CEOs, feeling the control pressure outside directors will bring on his/her decisions

(Donaldson 1990) and knowing that, under uncertainty, objective evaluations may cause long

discussions and conflict during decision making, may not be willing to set a cooperative and

collaborative ground for decision making. Thus, we propose;

Proposition 3a: Board independence will hinder board effectiveness in performing evaluation

task under perceived uncertainty.

Alternatively, following propositions 1b and 2b , we propose;

Proposition 3b: Board independence will enhance board effectiveness in performing

monitoring task under uncertainty when the uncertainty is due to information asymmetry.

4. Discussion and future research implications

This study introduces the type of (the source of) uncertainty (see Table 2) as a factor that

should be considered when determining board composition. For an effective decision control

on CEOs’ strategic decisions, firms operating under perceived environmental uncertainty need

to consider the competency of board members in evaluating strategic decisions blended with

managerial judgment. In this regard, we argue inside directors may be preferable to outside

directors as they can collaborate into decision making process more often and more actively

where they can experience the situations that call for CEOs managerial judgment. Outside

directors’ objective monitoring may be more essential for effective decision control under

uncertainty when the uncertainty is related to controlling CEOs’ actions and post

implementation period of strategic decisions.

Table 2: Board composition and effective decision control role

Source of uncertainty

In firm Outside firm

Director selection Outside directors Inside directors

Effective decision control

requirements

Objective monitoring Collaboration

Board incentive Independence Interpersonal Trust

CEOs’ developing trusting relations with directors may stimulate the collaboration required

under perceived uncertainty for an effective decision control. Thus, while board independence

may promote board effectiveness in implementing decision control under uncertainty when

uncertainty is related with information asymmetry, it may hinder effectiveness under

perceived uncertainty.

The link between uncertainty and board effectiveness can be enriched with future research.

The resource dependence perspective (Pfeffer, 1972; Pfeffer and Salancik, 1978) argues that,

rather than independent directors, “resource-rich” directors should be considered to be

selected as board members (Boyd 1990) so as to promote board effectiveness in performing

board roles. In addition to their expertise and ties to resource providers, outside directors may

be also selected due to their experience in similar organizations and contexts (Pfeffer and

Salancik 1978, Luoma and Goodstein 1999). Accordingly, depending on the specification,

outside directors can evaluate the managerial judgment embedded in strategic decisions, as

they may experience similar situations that result in formation of similar judgments. While we



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limited our discussion to outside vs. inside directors, future research may consider a richer

and more detailed taxonomy of director types (e.g. see Hillman et al 2000, Daily et al 1997,

Dalton et al, 1998, Anderson and Reeb 2005) in order to provide a better understanding about

the link between board composition and effectiveness under uncertainty.

With the same logic, future studies may adopt a more detailed specification of uncertainty to

explore the board behavior and board roles. Milliken (1987) specifies three different types of

environmental uncertainty which has different antecedents to decision making. In addition,

Dequech (2006) provides taxonomy on the degree and types of uncertainty. The effect of

different types and degrees of uncertainty on board composition and effectiveness can be

further explored to provide a fine tuning on the link between uncertainty and board

effectiveness.

Future research may focus on how trusting relations may be deployed between a CEO, and

the outside directors who are also mostly CEOs of other corporations. Nowak and McCabe

(2003) study shows the importance of quality and volume of the information flow which the

CEO makes available to outside directors. This flow is necessary for outsiders to perform

effective monitoring and evaluations on decisions. On the other hand, Holmstrom (2005)

argues that intense monitoring destroys the trust essential for the CEO to share important

strategic information with the direcors. In this regard, future research may particularly explore

the link between trust and information sharing in boardrooms which may have an impact on

effectiveness of boards in performing board roles.

This study has some practical utility, as well. This study, to be empirically tested, suggests

alternative propositions to AT logic by exploring a factor, uncertainty and highlights the

importance of using detailed specifications of factors and operationalization of taxonomy.

Knowing that AT independent-boards hypothesis has yet to be unequivocally supported, there

is a rising concern among scholars about the trend that demands supermajority or ideal boards

and the emergence of research that enrich the factors that affect board effectiveness, we invite

policy makers and business influentials such as institutional investors to reevaluate

“independent-board fits all” argument. This reevaluation is important because unified rules or

trends created and required may put enormous pressure on CEOs who are highly exposed to

social actors and in need of being legitimized for complying with those rules and trends. On

the other hand, those rules and trends may not fit in every context and consequently cause a

dilemma for top executives between having legitimacy or contributing to governance of their

firms effectively.

5. Conclusion

This study suggests between CEOs and directors both collaboration, for effective evaluation

task, and independence, for effective monitoring task, may be required under uncertainty.

While structuring a board for enhancing its contribution to a firm’s growth, director selection

will depend on the type of uncertainty that firms will address by evaluating their internal

operations and organizational environment.

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G9 - Bogac Kanadli - OfEL 2014