More and more companies are making way for a lead independent director, looking to the role as a power-sharing compromise between the CEO and chairman of the board.
Though considered a vital position, little is known about how companies get to this place. How is a lead independent director (LID) selected? What impact can a LID have on performance outcomes?
A new academic paper, “Compromise on the Board: Investigating the Antecedents and Consequences of Lead Independent Director Appointment,” examines the evolution of this role and answers key questions about its growing prominence in the corporate world.
Co-authored by Matthew Semadeni, a professor of strategy and Dean’s Council Distinguished Scholar, the paper is forthcoming in the Academy of Management Journal.
“Amazingly, there had been almost no empirical work looking at LIDs,” Semadeni says. “I think this is because the roles are so idiosyncratic. LIDs have very different roles from firm to firm.”
Without the academic study of this very important job, the work of LIDs has largely been anecdotal or conjecture, he says. Now, armed with the new research, the authors are interested in delving even deeper: examining how the use of LID changes in the firm when the person who is the LID changes.
For now, “Compromise on the Board” explores four key questions posed by authors Ryan Krause, associate professor of strategy at the Neeley School of Business at Texas Christian University, and Michael Withers, assistant professor of management in the Mays Business School at Texas A&M University and Semadeni. Those questions are:
- What drives a lead independent director appointment?
- When a LID structure is put in place, who is selected as the LID?
- Does appointing a LID impact performance outcomes, specifically annual stock returns, return on investment, and analyst recommendations?
- What effect does a LID appointment have on the likelihood of CEO/board chair separation?
Rise of lead independent directors
Boards are typically faced with tradeoffs when they join or separate the CEO and board chair roles, according to the paper.
“Unity of command, with a single individual leading the firm. This is very important in dynamic environments where strong leadership is required and the CEO/chair must communicate clearly to multiple audiences,” the paper says. “Also, it can provide the board greater insight into the day-to-day operations of the firm since the leader of the board is also managing the firm.”
“Joining the roles puts at risk the oversight role of the board because its leader is one of those it is evaluating. This has been colloquially referred to as ‘CEOs grading [their] own homework,’” the paper says.
The answer? For some companies, it’s separating the CEO and chair positions to prevent the inherent conflict of interest that arises when a CEO leads the board.
Corporate governance has come a long way.
In the early 1990s, nearly 80 percent of large U.S.-based firms relied on a single person to manage both the CEO and board chair role, the paper says. But corporate scandals and a policy change by the New York Stock Exchange impacting board governance prompted companies to take a tougher look at existing structures.
Ultimately, companies began moving toward a lead independent director position.
A 2013 paper validates this approach. Among other things, the “Director Compensation and Board Practices” paper from The Conference Board found:
- Nearly 70 percent of those surveyed felt that board independence is achieved through a LID. For financial firms, that percentage climbed to nearly 80 percent.
- Board independence was the most highly cited reason for having a LID.
- As the size of the firm increases (as measured in annual revenue), so does the belief that appointing a LID provides the necessary level of independence.
Key questions answered
Semadeni and his co-authors made several determinations through their research in “Compromise on the Board.” In answering four important questions, the authors shed new light on the lead independent director role.
Here are the top findings:
When is a LID selected?
To answer this question, the authors looked at the power conditions surrounding the decision to appoint a LID. Research suggests that the CEO holds onto the chair role when he or she is powerful relative to the board and is separated from the role when the board is powerful relative to the CEO.
If there is no power struggle? “We found that a LID was most likely to be appointed when CEO power relative to the board was balanced. In other words, when neither the CEO nor the board was powerful relative to the other, a LID was appointed to reflect this sharing of power,” the paper says.
Who is selected as the LID?
A company focused on shared power between the CEO and the board will look for a LID who takes a similar approach, bypassing the most powerful and the weakest independent board members. The favored candidate will likely have a “moderate” level of power. “This supports the notion that the person selected as LID is as important as the decision to appoint a LID,’ the paper finds.
The willingness to compromise — to appoint a LID and to agree on who is selected — is significant. The move, the paper finds, “is more than a symbolic gesture to appease the arbiters of good corporate governance; rather it indicates that the board is conscientious about who it selects for the role.”
What effect does LID appointment have on performance?
The LID role impacts corporate governance outcomes, but what about a firm’s performance? To measure this, the authors looked at annual stock returns, return on investment, and median analyst recommendations. The results support the importance of the power perspective to a LID appointment, the paper says.
The authors find that market and accounting measures are unaffected simply by the appointment of a LID. When they look at the LID appointment in conjunction with a CEO who has a low to moderate level of power, “there is a positive effect on market and accounting performance, underscoring the importance of relative power to the usefulness of having a LID,” the paper says.
The authors make similar findings in terms of the impact on median analyst recommendations. “This suggests that analysts view LID appointment favorably and that this favorable view is stronger when the power is balanced between the board and the CEO/chair,” the paper says.
What effect does LID appointment have on separation in the future?
If the firm sees smooth sailing ahead with the power-sharing arrangement, will separation be necessary? The authors say that once a LID is appointed, the likelihood of separation goes down by almost 60 percent.
The authors also looked at the effects of CEO power and LID appointment on separation. “We felt that perhaps the lowest likelihood of separation would occur when a LID is appointed and the CEO has high power, but testing this we found that there was no interactive effect,” they say. “This means that increasing CEO power does nothing to decrease the likelihood of separation beyond the decreased likelihood of LID appointment.”
Beyond these four questions, the authors also addressed the managerial implications of the LID role. Among the considerations for corporate governance practitioners:
- Balancing power between the board and the CEO won’t necessarily lead to a governance stalemate. “We find that at parity, both the board and the CEO are willing to make important concessions to the other to fashion a functioning governance arrangement for the firm,” the paper says.
- Sharing governance between the board and CEO is “legitimate in nature.” A firm can reach a meaningful compromise when the CEO agrees to the appointment of a LID with moderate power and the board is willing to accept a LID over the separation of the CEO and board chair positions.
- All CEOs don’t need to give up the chair role, despite calls from regulators and consultants to do so. Instead, the authors’ research suggests that boards and CEOs can reach a compromise that “preserves the unity of command provided by CEO duality while not sacrificing robust corporate governance, as evidenced by both the performance consequences and the staying power of the lead independent director position.”
Semadeni calls lead independent directors an “important innovation” in corporate governance.
“They provide advice to and oversight of the CEO while allowing the CEO to retain the board chair role,” he said. “We find that this innovation occurs and is best suited to situations where a power balance exists between the CEO/chair and the board.”
Read the Director Notes report adapted from, “Compromise on the Board: Investigating the Antecedents and Consequences of Lead Independent Director Appointment,” by Semadeni and his co-authors, Ryan Krause, assistant professor of strategy at the Neeley School of Business at Texas Christian University, and Michael Withers, assistant professor of management in the Mays Business School at Texas A&M University: Sharing the Lead: Examining the Causes and Consequences of Lead Independent Director Appointment