Board processes and the quality of board decision making: sometimes good boards of directors make bad decisions, but it's difficult to understand why. By considering some theories in group decision making, it's possible to glean a few solutions to the problem.

Students of group decision making have written extensively about what determines the quality of group decision making. Of particular interest are articles that explore the general theme of how or why a group of smart people can make terrible decisions--and, when confronted with overwhelming evidence that the decisions are bad, remain committed to such decisions.

This article considers how or why boards of directors sometimes make terrible decisions. Some commentators rely on variations of an incompetence argument to explain ineffectual board decision making; we will rule those out since there is considerable evidence to suggest that most board members are thoughtful, intelligent, and successful people. Instead, we look for other explanations for what are arguably bad board decisions.

Inattentive or compromised boards

Frauds and alleged frauds such as Enron, WorldCom, Global Crossing, Livent, Hollinger International, Adelphia Communications, and Parmalat have attracted immense attention in the financial press, which in turn have called into question the effectiveness of corporate boards. A common explanation for these failures has been executive greed, combined with a lack of board independence or board inattentiveness. Regulators appear to have accepted these explanations and have promoted requirements for more independent boards, and that senior management accept personal responsibility for their organizations' financial statements and systems of internal control.

We believe that prescriptions that focus on inputs to, rather than outputs from, the governance process are demonstrably ineffective because they fundamentally ignore that governance is conducted as a social process of group interchange and influence.

In this article, we consider the sources of weak board oversight resulting in failures to question bad executive decisions. While the fiduciary rather than the strategic/social focus of the current approach to improved corporate governance has merit, there is considerable evidence to suggest that boards that fail to challenge and advise management effectively destroy more stockowner wealth than management fraud or corruption.

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Weak board oversight

Most responses to governance failures have concentrated on specifying better structural inputs such as the composition and characteristics of boards of directors (the number, type, skills, number of meetings, director independence). In addition, they have promoted increased attention to systems of internal control in general and financial reporting in particular.

"Shaping good conduct," by Atkinson and Salterio (CMA Management, February 2002, pp. 19-23), concluded that the preoccupation of regulators and lawmakers with specifying inputs to the corporate governance process--the socially interactive ways in which governance practices and objectives are undertaken--is an incomplete and potentially less effective approach than one focusing on corporate governance objectives, designing Board social systems to achieve those objectives, and measuring performance on those objectives.

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A stinging article in The Toronto Star ("Directors missing in action," December 9, 2001) argued that while Nortel's board met most of the extant suggestions for the composition of a board, the board was, by any standard, ineffective.

  Ostensibly, Nortel's board was a model of good corporate governance.
  It was small--just 10 directors and, therefore, efficient. It was not
  stacked with insiders--non-executive, or independent, directors filled
  eight of the seats. And the positions of CEO and board chairman were
  not held by the same person.

The article went on to suggest that there was no evidence of independent thinking taking place on the board.

Air Canada has attracted similar commentary. As Terence Corcoran noted in the Financial Post (May 22, 2003):

  Air Canada's board is a model of independence. But guess what? It is
  now conventional wisdom that the airline's board, in bed with CEO
  Robert Milton, jointly and dubiously ran the airline into insolvency.
  Even the judge who's presiding over the airline's reorganization has
  raised doubts about the board.

While some may attribute these observations to spurious ex post facto reasoning, we believe that they, at the very least, suggest that while inputs to the board process such as skill, knowledge, and independence may be necessary they aren't sufficient to assure, let alone promote, an effective board. What is missing, we believe, is consideration of the structure and nature of board processes.

Gloria Stromber, a former commissioner of the Ontario Securities Commission, in her submission to the CICA/TSX Joint Committee on Corporate Governance, observed: "I suggest that the Joint Committee take a closer look at the whole subject of behavioural dynamics ... and on techniques and approaches to encourage more effective involvement."

We agree with Stromber, who has been further quoted as saying that there has been too much emphasis placed on defining the logistical structure of corporate governance and not enough emphasis on evaluating either the process or results of Board activities.

Group processes and decision making

James Surowiecki, author of The Wisdom of Crowds (Random House, 2004), outlines a number of conditions necessary to establish a wise group. These conditions include: diverse opinion, independent opinion, the ability of group members to develop and use task-specific individual knowledge in contributing to decision making, and the ability of the group to aggregate individual knowledge and judgment into a group decision.

One of the major focus areas for social psychologists is the way in which groups collectively decide on particular courses of joint action, and how in the process, individual judgment regarding effective or ethical action may be altered. Stated differently, social psychologists concern themselves with how a group may convince particular individuals to suspend better judgment to maintain group cohesion and conformity.

Social psychologists and psychologists have identified ways that group processes can inhibit each of the four elements Surowiecki has argued are essential for effective group decision making.

Diverse opinion

The requirement isn't only that boards be populated with people who are likely to have diverse opinions but that board processes actively promote the expression of diverse opinions. Common inhibitors to the expression of diverse opinions are statements like: "I am sure we are all on the same page," "We all need to be onside on this issue," or "Any thinking person will agree with this point of view." These statements are a form of social pressure to conform to group norms and beliefs and are often expressed to force convergence to a conventional point of view when an organization is under stress--a time when diverse opinions are potentially the most valuable.

Group members who legitimately question a group's direction are often labelled disruptive and are silenced by one institutional means or another. As a result, experts embedded in larger groups may have difficulty finding a common language to communicate their insights and skills, negating the potential contribution of expert knowledge. Studies of groups have observed that members undergo a process of socialization by which they learn group norms and expected behaviours communicated by central figures (such as board Chairs) in the collective. Certain leadership styles lead to socialization processes that, instead of promoting a thorough debate of issues, breed acquiescence by group members.

Social loafing is a motivational/cognitive state in which an individual sees little merit in working within a group despite being one of its members. Research suggests that loafing results when group members are relative strangers, meet infrequently, and share few social bonds. Contemporary boards of directors, by their design intended to ensure a diverse group with diverse opinions, are prime social contexts for loafing. Indeed, the movement toward independence may only exacerbate loafing conditions on boards.

When social loafing is left unchecked and becomes standard operational procedure in a Board culture, it may lead to a social psychological condition called herding. Herding involves the coalescing of group ideologies and practices around those of one central figure or small cluster of charismatic figures. Social groups beset with herding include members best described as sheeple; those who accept dominant lines of thinking without criticism or reflection, and view more utility in maintaining the status quo than upsetting the proverbial apple cart. Although extensive loafing in a group isn't a prerequisite of herding behaviour, excessive loafing is indeed a strong predictor of the development of sheeple cognitive states and social practices within a group. The sheeple phenomenon may be one characteristic of boards that observers characterize as inattentive or failing to challenge important management strategies or decisions.

Independent opinion

While regulators and commentators have commented on the importance of board members being independent of senior management, there has been little discussion of the importance of board members acting independently--which, as we have just argued, the practice of constructing diverse boards without regard to appropriately managing board processes may work against.

Students of board decision-making behaviour appear to have documented two major obstacles to the exercise of independent opinion. The first is the failure to develop and use board processes that effectively exploit board members' diverse opinions and skills, and the behaviour of individuals in general when under stress.

Behavioural theories in social psychology suggest that unless properly managed, groups of experts may encounter serious impediments in exercising their skills in evaluating and advising management.

The antithesis of independent group thinking is a phenomenon known as groupthink--a situation in which group members adjust their individual opinions to what they perceive as the group consensus. This often results in a situation in which the group ultimately agrees on an action that each member might individually consider unwarranted, irresponsible, unethical, or irrational. Indeed, there is more than ample evidence to suggest that boards of directors, at least historically, have been rife with groupthink tendencies. When groupthink manifests into board of directors culture, there is a marked reluctance to change, innovation, and self-examination among directors.

Collaboration is a way to get everyone involved by assigning each member unique tasks and responsibilities. It is a way for group members to share diverse knowledge, and assess the tasks to be fulfilled unfailingly. Content recognizes the centrality of the individuals' specific tasks within the group decision-making process. If group members envision their roles as contributing to the completion of a worthy task, then they are more likely to attribute their work efforts to their sense of self and participate with more frequency and quality. Choice provides group members with an opportunity to choose the task they wish to fulfill; in other words, it allows for individual agency within the group. Arbitrarily assigning roles in a group often causes complaints, disinterest, resistance, and frustration. Permitting members to choose their role stimulates team-building and co-operative work.

Psychologists have studied extensively the bases of the tendency of people to conform to a conventional wisdom when under stress. They have coined terms such as irrational escalation of commitment (by some accounts, recently exhibited by the exuberant bidding for Dofasco) and the sunk cost phenomenon (1) to describe widespread human behaviour. These behavioural tendencies along with the self-esteem issue of not wanting to be proven wrong tend to promote the suspension of individual opinion and choosing an existing course of action long after a more dispassionate observer would have called for change.

This board tendency may be exacerbated by the common phenomenon of executive over exuberance which Dan Lovallo and Daniel Kahneman, in a July 2003 Harvard Business Review article ("Delusions of success: how optimism undermines executives' decisions"), attributed to widespread human traits such as a tendency of individuals to: overestimate their talents, underestimate the risk associated with their decisions, and subconsciously bias processing information to support their current point of view.

Some observers have argued that an effective way of promoting the independent expression of opinion is to formalize the devil's advocate role in board considerations of proposed major management initiatives. The role of devil's advocate depersonalizes the expression of a contradictory point of view, institutionalizes consideration of alternative points of view, and may encourage people who are otherwise hesitant to speak against a proposal that seems widely accepted.

Developing and using individual knowledge

It is important that individual board members are given the information they need to enhance the intellectual capital they bring to the board, while sustaining their individual perspective and opinion. The common practice of providing all group members with the same information package--usually centred on financial or accounting-based reports--doesn't necessarily support this idea. Board members should be able to solicit and evaluate the type of information that they want, not what is dictated and directed by senior management. What remains a challenge, however, is developing an effective means to promote collaboration and solicitation of the views of the various experts that constitute the board.

Aggregating individual knowledge and beliefs

Perhaps the most difficult challenge in organizing and managing board processes is developing an effective means to solicit and discuss the knowledge, skills, and beliefs of individual board members. This is perhaps the most challenging role of the board Chair, since it means developing a common platform that promotes individual contributions to the group discussion and decision.

Forcing board members to evaluate a proposed course of action by focusing on aggregate financial returns and risk may be the least effective way of soliciting board participation because it centres the discussion on an abstract language (accounting) that may be neither accessible to individual board members, nor possess the requisite variety of information to solicit contributions from individual board members. What may be more effective is a strategy map approach that lays out the logic of a proposed course of action so that board members can contribute their specialized skills and insights in a cause and effect model that is based on functions.

Conclusions

While the manipulation of board inputs through independence structures continues to receive considerable support in governance circles, sociologists and psychologists both agree that decisions are made interactively and interpretively as a process and not merely via a structure of inputs. Therefore, if governance experts continue to focus on the form of decision making over the content of the process, there is reason to believe that governance 'meltdowns' will continue.

To move toward a more process-sensitive culture of governance, three immediate considerations might be explored. First, Chairs could attempt to engender both task and relation-oriented atmospheres in the boardroom. In short, most groups look to one or several leaders to set the tone for group interaction. By creating contexts wherein individual members understand that they are responsible for contributing to group discussions and proposing amendments to management's strategic directions (the task) and in which diverse knowledge bases are openly sought out and supported as part of the team perspective (relationship building), greater critical deliberation in boards should result.

Second, speaking rituals must be created in the boardroom to create dialogue and interchange as habitual behaviour. Groups tend to fall into interaction habits, and unless these are recognized and disrupted they will continue. The literature on groupthink, herding, and the escalation of commitment teaches us this plainly. Careful attention, then, must be given to hearing from all board members at every meeting. This might be done by simply asking members to contribute a report or analysis at each meeting, offer a critical evaluation of other board members' inputs, or suggest five reasons why management's decision/direction might fail from their perspective as an expert.

Third, and perhaps most consequentially, for members of groups to care about providing insight and performing with a high level of interest, their efforts must be socially and institutionally recognized. The analysis of loafing illustrates how, when members of a group feel ineffectual or without agency, they stop producing. To discourage loafing and encourage careful analytical work within the boardroom, members' insights must be routinely inserted into strategic decisions and be presented with reaffirmation of their efforts by management. Stated differently, board members must be told they are actually doing a good job if we want them to continue performing the associated roles. We feel that while good governance tends to be a veritable black box within the extant literature, a series of very basic group tendencies and processes teach us how to cultivate better corporate governance in Canada and elsewhere.

Anthony Atkinson, CMA, FCMA, is a professor in the School of Accountancy at the University of Waterloo and the Management Accounting Area Head. Michael Atkinson is an assistant professor and undergraduate chair of the department of sociology at McMaster University.

(1) The sunk cost phenomenon, also known as die Concorde fallacy, is the act of treating costs resulting from past decisions as relevant in a current decision. Some researchers believe that the sunk cost phenomenon is deeply ingrained in human behaviour and is rooted in evolution reflecting the need to conserve scarce resources by seeing a course of action through to its end. Some researchers believe they have seen the sunk cost phenomenon exhibited by birds. Kacelnik, A. and Marsh, B. (2002). "Cost can increase preference in starlings," Animal Behaviour, 63, 245-250 and Anton D. Navarro and Edmund Fantino. (2005) "The Sunk Cost Effect in Pigeons and Humans," Journal of the Experimental Analysis of Behavior. 83, 1-13.

By Anthony Atkinson, CMA, FCMA, and Michael Atkinson