The Role of the Board of Directors in Practical Terms

Author(s): Gideon Chitayat

Source: Management International Review, Vol. 24, No. 1 (1984), pp. 71-77
Published by: Springer
Stable URL: http://www.jstor.org/stable/40227708
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G. Chitayat*

The Role of the Board of Directors in Practical Terms

In recent years a considerable number of articles have been written on how boards of
directors should be organized (Pfeffer, 1972; Chitayat, 1980, 1981), what the functions
of the board should be (Lavenstein, 1982; Andrews, 1981), and in particular what role
the board should play in planning (Weber, 1979; Tashakori and Boulton, 1983). Dif-
ferent alternatives have been suggested as ways of improving the board's performance,
such as separating the role of chairman from the role of chief executive officer (Puckey,
1969; Brown, 1976), and changing the composition of the board to include more out-
side directors (Jain, 1980; Hill, 1979). In a theoretical framework these suggestions ap-
pear to offer a valuable solution to some of the problems facing boards of directors and
management today.
The objective of this study, however, is to examine to which extent the board of direc-
tors performs three major functions:

1. to initiate strategic proposals, and to establish goals, objectives, and major policies of
the company;
2. to exercise their approval power, accepting and rejecting strategic proposals raised
by the Chief Executive Officer (CEO) or by the executive branch of the company, and
hiring or firing senior executives;
3. to evaluate the overall performance of the company and to review the performance
of the CEO and other senior executives.

The second objective of this study is to examine what boards of directors with chair-
manships separate from the role of the CEO and a majority of outside directors are
actually doing.

Method

Sample

The initial sample for this study consisted of 35 boards of directors of large companies1
in a wide variety of durable, non-durable and service industries in Israel. During this
study, twenty chairmen and thirty CEO's participated in personal interviews. The in-
depth interviews lasted from one to three hours and covered a predetermined set of
topics. Confidentiality was promised in order to obtain an open discussion.
Unlike boards of directors in the United States and the United Kingdom, most boards
of this sample have only one inside director among their executives, namely the
managing director. 2 However, the non-executive directors are not necessarily outside
directors. In many cases, boards consist of major share-holders, bank officials, lawyers

* Dr. Gideon Chitayat, Graduate School of Business, Hebrew University of Jerusalem, Israel.
Manuscript received July 1980, revised November 1983.

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representing individual partners, and executive directors from the parent company or
the holding company. Outside independent directors are appointed mainly to the
boards of the state-owned companies.3
Only three of the chairmen who took part in the study held the position of Chief
Executive Officer, and four acted in a full time capacity. All others held a part-time po-
sition, while holding full time positions in another company. The boards of directors
studied ranged in size from five to fifty-seven members, with an average of thirteen. In
the private sector, boards tended to be smaller than in state-owned companies, ranging
in size from five to thirty-two members, with an average of eleven. In state-owned com-
panies, to board averaged twelve directors, with a range of seven to twenty.
In 54.1 percent of the companies observed, the boards met more than six times a year.
Boards of private enterprises met six times a year or less. Most boards of state-owned
companies met several times a year or more.4 Most of the boards studied had at least
three standing committees, i.e., the executive committee, finance or audit committee,
and- compensation committee. In some companies, the executive committee was em-
powered to direct the affairs of the company during intervals between meetings of the
board of directors.
Forty percent of the board interviewed did not receive written background information
in advance except for annual financial statements. Important reports were given orally
during the meetings. About one-third of the boards received background material up to
three days or less before their meetings; the rest received written reports and back-
ground material at least six days in advance.

Initiating Strategic Directions

Chairmen and managing directors were asked to describe the extent to which they initi-
ated strategic proposals and established objectives and major policies through request-
ing the managing director or other executives to act. They were also asked to identify
who, among them, did the initiating - the chairman, the managing director or individual
directors (Table 2). Most responses revealed that boards of directors did not determine
either the company's objectives or its general policies, or specific matters. The majority
of those interviewed named the chief executive officer as the major initiator of strategic
proposals, as well as specific short-run issues, regardless of whether he was the manag-
ing director or the chairman.
Many chairmen and directors attributed their lack of involvement in critical company
decisions to their lack of time. As part-time chairmen or outside directors, their pri-
orities did not necessarily include board business. Summarizing the interviews one can
identify the following arguments which justify the limited role of the chairman and the
individual directors in initiating strategic directions.

Table 1: Initiation and Type of Proposals

Total Strategic proposals Specific matters

Total 100.0 100.00 100.00

Board 6.6 12.50 0.00
Chairman 26.7 31.25 21.40
Managing Director (CEO) 66.7 56.25 78.60

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The CEO rather than the chairman or the board of directors has the sole responsibility
for initiating proposals, which should be done by the executive group, while the board
of directors should participate at the final stage of the strategic process.
The complexity of the business requires extensive information analysing the business
environment such as industry structure, world-wide competition, development and
innovations in technology. The processing of this type of information requires a special
staff of experts. The board of directors has no access to this kind of personnel.
Initiating strategic proposals requires an understanding of the overall operation of a
company. The limited time and skills of outside directors are the major obstacles in ini-
tiating strategic proposals and the overall strategy of the company.

Approval Power

Chairmen and CEO were asked to identify who actually had the power to approve stra-
tegic proposals. Those proposals that are effective over long periods of time, affect the
whole enterprise and consume a significant portion of the company's scarce resources.
The approval of power of strategic decisions is the final stage of strategy formulation.
The objective of this study was to identify the source of power in the decision making
process. Thirty percent of those interviewed identified the managing directors (CEO) as
having the final approval power, while the board of directors have nominal power.
Another thirty percent of the sample who were all holding positions in boards of direc-
tors of state-owned companies (Chitayat, 1980) identified government officials as hav-
ing final approval power, while boards in these companies exercised limited power
(Table 2).

Table 2: Approval Power of Strategic Proposals

Source of power Overall Companies in State-owned

sample private sector companies

Total 100.0 100.00 100.0

Board of Directors 16.7 31.25
Chairman 10.0 6.25 14.3
Managing Director (CEO) 30.0 50.00 7.1
Chairman and Managing Director 13.3 12.50 14.3
Government Officials 30.0 - 64.3

Surprisingly, approximately one-third of the chairmen and managing directors in the

private sector identified the board of directors as having the actual power to approve
strategic decisions. The decision making process in these companies required the CEO
to approach some individual directors prior to the board's formal meeting in order to
obtain approval of the recommendations. In most cases, the CEO approached several
influential directors - major shareholders, bankers, personal friends - on an informal
basis to have their opinions on his strategic decisions.
However, as Table 2 indicates, executives and government officials, rather than direc-
tors, approve strategic decisions. Initiation and formulation of proposals in most cases
come from the executive group. The absence of initiation by the board of directors
holds even for major investments on rapid expansion.

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In spite of the fact that board's approval power is more important than the initiation
and formulation of strategic proposals, many chairmen and managing directors in-
terviewed indicated that their board of directors are completely passive. The approval
process of the board is largely a formality and automatically provided.
Chairmen stated that the major reason for directors to exercise only nominal approval
is due to their limited involvement in the companies' activities and to the concentration
of power in the hands of the CEO and his senior executives.
Boards in this sample did not exercise their power to hire the chief executive officer.
Moreover, the board in most cases did not ordinarily provide the final approval of hir-
ing senior executives. The CEO supplied the reports, and summaries of his decisions
were usually brought to the board's attention to obtain formal approval for the hiring
process.
The boards of directors included in this study did not choose the managing director of
their companies. In instances where a new managing director needed to be appointed
(25 percent of the companies), one or two major stockholders or the previous managing
director made the selection of the newcomers. In all cases, the boards automatically ap-
proved the appointment of the managing director and other senior executives.

Reviewing Performance

The chairmen and managing directors interviewed explained that their boards did not
exercise an important role either in reviewing the performance of the managing direc-
tor (CEO) and his senior executives or in developing management succession and the
selection of managing directors. Eleven managing directors of private enterprises and
nine managing directors of state-owned companies were asked if their boards of direc-
tors had reviewed the overall performance of the company and their performance over
the past year:

Table 3

Overall Private companies State-owned

companies

Yes No Yes No Yes No

Overall performance
of the company 45.0 55.0 54.5 45.6 33.0 67.0
Managing director's
performance 15.0 85.0 18.2 81.8 11.2 88.8

Some managing directors explained that their boards evaluated the overall perform-
ance of their companies by focusing on the annual financial statements. In many in-
stances, this evaluation took place during the approval of the proposed annual budget
and the formal approval of the financial statements. Few boards used other factors in
addition to net profits, such as the annual rate of growth, R & D projects, developing
new markets, and management succession, in their evaluation of overall performance.
In most cases, board of directors did not conduct a formal appraisal of the managing
director's performance.

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Judging from the responses given in interviews, it is clear that many directors and
chairmen view their companies' annual show of profits as the indicator of success or
failure in management.

What Do Boards Actually Do?

Individual directors provide the CEO advice and suggestions. In some cases, CEO pre-
ferred to approached several directors on important matters before the board's formal
meetings. The opinions of these particular directors may have some effect on the CEO
decision. In three major areas the boards have greater impact on the following:
1. Most managing directors (90 percent in this study) indicated that individual directors
provided them with advice and counsel on strategic matters and on particular areas of
expertise. This has been particularly fruitful as the company enters to new businesses or
larger investment.
Clearly, the success of the board of directors in providing expert advice and counsel to
the CEO depends primarily on the individual influential directors, their managerial
skills and business experience. Data from various interviews, however, suggest that
managing directors seek advice on an individual basis and through informal contacts
with their directors rather than in formal meetings of their boards.
2. Managing directors acknowledged the importance of individual directors in provid-
ing external contacts for their companies. A non-executive director or a part-time chair-
man may develop personal relationships with business leaders, from other organi-
zations. Managing directors indicated that they can utilize the external relationships of
their boards to advance the company.
3. Both chairmen and managing directors, mostly in their private sectors, indicated that
in some cases boards became involved in the day-to-day operations in certain business
situations such as sharp decline in profits or market shares and sustained capital losses.
In some cases, the involvement of the board increased whenever they had a newly se-
lected managing director. The death of a powerful managing director was also cited as
a time when the board of directors became involved in day-to-day operations.
In boards of state-owned enterprises most of the chairmen and the managing directors
indicated that their boards became involved in day-to-day activities mainly at unrest
industrial relations strikes and other labor disputes. Moreover, the indiviudal ministers
became directly involved in the negotiation process.

Conclusions

From the data and analysis presented in this study, the following conclusions can be
drawn:
Boards of directors of companies in the private sector as well as public sector do not
perform the three functions considered to be the 'should be's of the effective operation',
namely:

a) Initiating strategic proposals and establishing objectives for the company by re-
questing the managing director or a committee to formulate and present rec-
ommendations.

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b) Having the final approval power strategic decisions. Most boards have the final
authority in theory, but in practice approve nominally and automatically the pro-
posals of the chief executive officer.
c) Evaluating the overall performance of the company quantitatively as well as quali-
tatively, reviewing the performance of the managing director and his senior
executives and, in some cases, selecting the managing director.

These three functions are not performed by boards which separate the role of chairman
from the role of the CEO. They are also not performed by boards having a majority of
outside directors as are boards of directors of state-owned enterprises.
In general, managing directors do not want their boards to deal with the strategic and
overall policies of the company during the formal meetings of the board unless they
already have the informal blessings of the majority of directors. They prefer to consult
with individual directors informally and at their own discretion.
Managing directors, in general, prefer to have prestigious, well-known directors on
their boards who may not attend board meetings, rather than having professional
directors with no contacts who attend all the meetings. 'Big names' may provide chan-
nels of informal communication to government and other external interest groups.
Boards become heavily involved in the daily decision-making processes of operational
activities when new managing directors are being considered. Once the managing
director becomes familiar with the business practices of the company, the board termi-
nates its active involvement. In most instances, a board's involvement in its company's
day-to-day activities is transitional and lasts only for a limited period of time.
In conclusion, a not wholly unfamiliar observation can be made about theory and prac-
tice: the role of the board of directors in practical terms differs substantially from the
role of the board of directors as defined in theory.

Footnotes

1 19 companies are state-owned enterprises or mixed owners while 16 companies are privately
owned, whose shares are on the Tel Aviv Stock Exchange.
2 Managing directors, in this study, are the highest executives in the management hierarchy, re-
gardless of the titles. The managing director has authority over all other executives and is re-
sponsible only to the board of directors. In Israel, the managing director is also the CEO and
has other titles such as president, who is also a member of the board, and general manager, a
president who is not a member of the board.
3 See Chitayat, G. (1981), p. 44.
4 The boards of state-owned companies are required by the law, Section 26 (a) to meet at least six
times a year.

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