(2015). Activists' secret ally: Big mutual funds – large investors quietly back campaigns to force changes at US companies. Wall Street Journal, www.wsj.com, August 10 www.wsj.com/articles/activist-investors-secret-ally-big-mutual-funds-1439173910; Coffee J. C., & Palia, D. (2016). The wolf at the door: The impact of hedge fund activism on corporate governance. Journal of Corporation Law 41(3): 545–607; Baigorri, M., & Kumar, N. (2017). Black swans, wolves at the door: The rise of activist investors. Bloomberg, www.bloomberg.com, July 12; Christie, A. L. (2019). The new hedge fund activism: Activist directors and the market for corporate quasi-control. Journal of Corporate Law Studies 19(1): 1–41; Wong, Y.T.F. (2020). Wolves at the door: A closer look at hedge fund activism. Management Science 66(6): 2347–2371.
For board members to affect strategic governance, the same standard applies. Corporations often replace one or more directors each year. Each replacement represents a chance to shape the board to meet the corporation's strategic needs. An unexpected death of one director can shape corporate acquisitions strategy, which indirectly shows the impact on strategy that even one director can have.36 Not surprisingly, nominating committees increasingly seek board members with specific functional expertise, such as in labor, environmental, compensation, or public policy. For example, when a firm is experiencing operational problems, appointing a chief operating officer (COO) or CEO with operational experience from another firm helps the appointing firm to improve its performance.37
FIGURE 1.2 Board diversity of S&P 1500 firms.
Nomination committees may also seek directors to match diversity characteristics of customers or to extend operations into global markets. Diversity may improve board effectiveness. Growing evidence suggests that board gender diversity is associated with a number of desirable organizational outcomes, such as avoidance of securities fraud,38 more vigilant monitoring of the top management teams,39 more ethical firm behavior,40 and higher accounting-based performance and stock market returns.41 As Figure 1.2 shows, boards have become more diverse over time in regard to appointing more females and ethnic minority members. But these positives are stymied if, for example, solely one woman is placed on a board as a token to create institutional legitimacy.42 Recognizing the positive effects of diverse membership on boards, institutional investors are using their power to push companies to appoint more women and minorities. For instance, BlackRock, a large mutual fund manager, suggested that diverse boards “make better decisions” and that it planned to focus on the issue in discussions with company leaders ahead of annual meetings.43 Yet we note that diverse demographic characteristics do not always mean that the new “diverse” members will have diverse opinions as current board members. For example, directors are inclined to select a demographically different new director who can be recategorized as an in-group member based on his or her similarities to them on other shared demographic characteristics, and such recategorization also increases demographically different directors' tenures and likelihood of becoming board committee members.44 We also note that board demographic diversity can be detrimental to unity among members, making firms become attractive targets for hostile stakeholders; interestingly, as a result, firms with a more demographically diverse board are more likely to be targeted by activist investors, presumably because boards are unable to form an effective coalition against activist investors.45
The nominating and governance committees—sometimes held as a single, combined committee—carry out important functions. The governance committee can conduct a management audit, assessing the capabilities and potential of the company's board and management team, and suggest training to sensitize the directors to environmental, regulatory, or diversity issues that affect strategy. Such an audit focuses board attention on human assets and helps plan changes in leadership. In fact, succession planning forms another crucial issue under the purview of the governance committee. When a CEO is dismissed or moves to another firm, a board of directors without a strong succession plan may scramble for a replacement, which may lead to serious strategic consequences. Many boards have authorized their nominating committees to seek out potential executive talent to avoid shocks upon surprise departures. Some boards hold an annual joint session of the compensation committee, the nominating and governance committees, and the executive committee to discuss succession planning and executive resource development. Another important issue lies in appointing qualified board committee chairs. When highly qualified chairs are passed over and less qualified members receive chair appointments, the selections can lead to a negative board climate,46 which also may affect strategic governance. To avoid pitfalls from inadequate chair appointments or succession shocks, directors should formalize succession processes that can improve their information collecting and processing abilities and give rise to a greater quantity and quality of qualified chairs and CEO candidates.47 The following example demonstrates the hazard in not having a succession plan in place.
In mid-2020, leaders of Cerberus Capital Management, a private equity firm holding more than 5 percent ownership of Commerzbank, the second largest German bank, sent a letter to the board chair that the bank “has not presented a coherent strategy and has failed to implement even its own progressively less-ambitious plans.” Cerberus heads wanted to name two new supervisory board members to encourage significant changes to Commerzbank's supervisory board, management board, and the strategic plan. One month later, over disagreements with Cerberus (the bank's second largest shareholder), Commerzbank CEO Martin Zielke announced unexpectedly that he would step down from his position. The abrupt announcement came as a surprise and reduced the value of the firm, while the departure left a governance void at the bank.48 Compared to German competitor Deutsche Bank's 1 percent loss, Coomerzbank shares fell 26 percent, when a new CEO was appointed in September 2020.49
Although board committees supervise managerial incentives and behavior, the relationship between committee chairs and top managers does not have to be adversarial. In fact, the compensation committee sets appropriate incentives so that the top managers, especially the CEO, will work on behalf of shareholders and stakeholders to create a strategy and make strategic decisions that will build both firm growth and stakeholder wealth. Pay structure for the top management team by the compensation committee creates a definite strategic governance issue.50 A large pay differential among top management team members can give rise to problematic social comparison, since a smaller number of officers may get large pay packages, whereas others receive less.51 Large pay dispersions can generate less cooperative teamwork and less effective overall
