One or Two: Ensuring Director Contributions to Organisational Outcomes in Two Tiered Governance Structures

1. One or Two: Ensuring Director Contributions to Organisational Outcomesin Two Tiered Governance Structures Martin Laverty Doctoral candidate Business School, Faculty of the Professions, University of New England

2. Download this presentation www.betterboards.net/oneortwo.pptx

3. Learnings from doctoral thesis “What, if any, corporate governance approaches might optimiseorganisational performance within human service organisationsutilising two tiered boards?”

4. Why two-tier boards? Federations face tension in the balance between demand for efficiency through centralisation and competing need for representation of constituent bodies, causing federated bodies to spend energy discussing and modifying structures of governance (Widmer and Houchin 1999, Cornforth 2012).

5. To answer the question… Presentation Structure • What is known about the scale of the Australian not-for-profit sector • Theories and practice of governance in the not-for-profit sector • Assessment of not-for-profit organisational performance • 12 identified links between board governance and organisational performance • Framework for board directors to contribute to organisational performance

6. Australian Not-for-profit sector • 600,000 not-for-profit organisations • 59,000 economically significant • Employ 8% of Australia’s total workforce • Contribute $43 billion annually, or 4% of GDP (Productivity Commission 2010)

7. Theory of not-for-profit governance • Corporate governance is the mechanism by which those providing capital to corporations satisfy themselves that a return on their investment will be provided (Shleifer and Vishny 1997). • The non-distribution constraint prohibiting profits being paid to founders is at the core of the character of a not-for-profit organisation’s governance (Hansmann 1987). • Stakeholders of not-for-profit organisations take on characteristics of the principal or shareholder, such that there is a “multiple principals” framework within which corporate governance occurs. Those identified as capable of inclusion within the group of multiple principals include donors, volunteers, consumers, beneficiaries and staff members. (Jegers 2009).

8. Practice of not-for-profit governance • The design of a set of institutions such as boards and board committees to force or induce the welfare of shareholders to be pursued by management is what has come to be known as corporate governance. (Tirole 2001) • Contemporary governance is mostly a response to the needs of owners of for-profit corporations; little attention has been given to if for-profit corporate governance practices actually suit the unique needs of not-for-profit organisations. • Corporate governance of not-for-profit organisations in Australia is mostly exercised through a single or unitary board. Some organisations are governed through a two-tiered board. Not-for-profit governance research is partly limited because of its narrow focus on unitary governance, whereas in practice federations, subsidiaries, and multilevel complex governance structures have evolved in many non-profit organisations. (Cornforth 2012).

9. Practice of two-tiered governance • Two-tiered boards operate by separating executive and non-executive directors with specific roles and legal responsibilities. (Bezemeret al 2012) • The two-tier structure sees the supervisory (or higher tiered) board simultaneously act on behalf of the shareholder as agent, and direct the management (or lower tiered) board as principal. (Triole 1986) • Subsidiary boards, which are arrangements where a controlling board creates or mandates a subservient board with an assigned role are treated differently to two tiered boards. So too are the relationships between boards in a federated structure. However, the dynamics of the two-tiered structure can inform the practice of subsidiary or federated board practice.

10. Use of two-tiered boards • Germany first enshrined two tiered boards into corporate law in the nineteenth century; the German template has since been utilised in central-Europe, Latin American countries, China and east-Asia. (Goo & Hong 2011) • 22.6% (or 6,419) of Australia’s total private hospital overnight stay beds are operated by not-for-profit organisations that utilise two-tiered boards of governance that are consistent with the Germanic framework.

11. Assessment of not-for-profit organisational performance • Performance of not-for-profit organisations on the other hand has been said to be a social construct, and its determination depends on who you ask. (Herman & Renz 1997) • Accounting and market measures are the key methods of determining for-profit corporation performance. (Wang and Clift 2009) • Assessment of 149 publications in the decade leading to 2006, common measures of performance were found to be (a) efficiency or productivity, (b) market share, (c) customer satisfaction, and (d) quality. (Baruch& Ramalho 2006)

12. Governance/organisational performance link 1 – Basic Board Functionality • Before a board can contribute to an organisation’s outcomes, it needs to first be able to function properly as a board itself. • Boards contribute to value creation when their director members both individually and collectively are able to effectively fulfill their board roles. (Huse, Gabrielsson, and Minichilli 2005) • Effective boards have four roles of monitoring, providing strategy, providing advice, and enabling access to capital; ultimately organisational performance is influenced by board effectiveness. (Nicholson and Kiel 2004)

13. Governance/organisational performance link 2 – Monitoring of performance • Board should determine what it requires by way of organisational performance, and then focus its monitoring effort on achieving this performance. • Not-for-profit status itself, and the unclear nature of some goals of not-for-profit organisations, limits the accuracy of relying on financial performance indicators alone (Brown 2005) • It is not clear what a not-for-profit manager is meant to maximise; choosing what it is the not-for-profit manager is to maximise is key to the board being able to assist the organisation’s performance. (Eldenburg et al 2004)

14. Governance/organisational performance link 3 – Board Makeup • Anglo-American studies of for-profit corporations do not support selection of ‘independent’ directors as necessarily adding value to the corporation’s performance. (Lawrence and Stapledon 1999) • Where directors are selected in order to bring diversity of skills, thought, and experience to the board, a study of more than 6,000 for-profit firms between 1991 and 2003 found no causal link between diversity and firm performance. (Wintoki, Linck, and Netter 2009) • Smaller boards have been shown to have a positive impact on for-profit corporation performance. (Hermalin and Weisbach 2001)

15. Governance/organisational performance link 4 – Strategy Engagement • Strategic input is the key method by which a board can influence a for-profit corporation’s performance. (Huse and Rindova 2001) • Corporation performance has been found to be ultimately linked to strategy, such that board attributes might be of little consequence except to the extent they influence strategic thinking and its implementation. (Heracleous 2001) • Unfortunately, boards have been found in practice not to be deeply involved in strategy setting, with many involved only in strategy ratification rather than its formation, with CEOs playing the leading role in strategy development. (Finkelstein and Hambrick 1996)

16. Governance/organisational performance link 5 – Participation • Participative boards correlate with higher financial performance. (Heeracleous 2001) • Organisational effectiveness has been found to relate confidence of board directors in the understanding of their responsibilities. (Herman & Tulipana1985) • Gender, experience as a not-for-profit director, service on other not-for-profit boards, mission attachment, and training have been found as the best indicators of confidence and participation in board governance. (Brown, Hillman, and Okun 2012)

17. Governance/organisational performance link 6 – Reward “ownership” • Stock ownership by board members in particular has been found to correlate with improved operating performance (Bhagat and Bolton 2008) • Directors on average may not be sufficiently rewarded to fulfill their functions adequately (Denis 2001) • Directors who are not remunerated sufficiently lack the incentive to contribute fully to their board role.

18. Governance/organisational performance link 7 – Transparency • Firms that have higher levels of corporate transparency have been found to demonstrate better performance. (Chiang, H-tsai 2005) • Favourable accountability assessments have been found to increase donor contributions, which in turn contributes to organisational performance (Sloan 2009) • A not-for-profit organisation’s accountability is determined by a combination of its strategy, capacity, governance, and contextual engagement with its particular stakeholder groups (Saxton and Guo 2011)

19. Governance/organisational performance link 8 – Donor monitoring • Major donors on a not-for-profit board have been found to perform a monitoring function motivated by their investment in the organisation, just as large shareholders do in a for-profit corporation. (Brown 2005) • A significant association has also been found between organisational efficiency and boards that comprise major donors. (Callen, Klein, & Tinkelman 2003) • Donors who participate in a not-for-profit organisation’s board governance by setting objects and directions have been found to enhance organisational efficiency. (Van Puyvelde et al 2012)

20. Governance/organisational performance link 9 – Resource attraction • Board directors engaged with resource gathering activities including fundraising and the making of personal contributions have been found to participate on boards more associated with improved organisational performance. (Brown 2005) • Boards require resource providers, advisors, mentors, decision makers, evaluators, and negotiators, and each of these skills must function simultaneously in order for value creation to follow. (Huse, Gabrielsson, and Minichilli 2005) • Appropriate board size, tenure, chair tenure and business executive background have also been found to correlate with improved revenue and gift income of not-for-profit organisations. (Olson 2000)

21. Governance/organisational performance link 10 – Stability • Poor financial performance of a series of American not-for-profit organisations was found to relate to high board and CEO turnover. (Eldenburget al 2004) • A board’s purpose is ultimately to enable cooperation. (van Ees, Gabrielsson and Huse 2009) • Alignment of the resources of knowledge, experience, relationships and procedures with the Board’s required role set determine the ability of a board to achieve corporate objectives. (Nicholson and Kiel 2004)

22. Governance/organisational performance link 11 – Independent supervisory board • Genuinely independent supervisory boards in Germany and Austria have been found to correlate with improved firm performance. (Velte 2010) • Larger and more active supervisory boards were found to improve earnings returns and have higher quality reporting (Firth et al 2007) • Active and large supervisory boards in China have been found to be associated with more robust financial reporting and increased earnings, but too many members leads to less effectiveness. (Jia et al 2009)

23. Governance/organisational performance link 12 – Professionally matched supervisory boards • Where supervisory boards comprise members with appropriate professional knowledge, work experience, and independence from management they have been found to be more likely to be able to improve organisational performance. (Shan & Xu 2012)

24. Single and two-tiered boards Two-tiered boards only • Strategy engagement • The Board should develop the capacity of it and its members to actively engage in strategy and strategic decisions. • Functionality • Basic board functionality is essential in being able to contribute to organisational outcomes. • Donor monitoring • The Board should enable active participation of major donors in governance. • Independent • A supervisory board should work to be genuinely independent. • Participation • The Board should develop each board director’s capacity to participate fully in the affairs of the Board. Framework for not-for-profit board directors to contribute to organisational performance • Monitor performance • Board should define meaning of organisational performance and monitor the board’s contribution towards it. • Resource attraction • The Board should engage directors in resource gathering. • Professional match • A supervisory board should comprise members with appropriate professional knowledge and work experience • Reward “ownership” • The Organisation should empower and reward board directors as “owner shareholders.” • Makeup • The Board should determine its appropriate independence, composition, and size. • Stability • The Board should work towards low board and chief executive officer turnover. • Transparency • The Board should adopt a transparent governance processes.

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26. mlavert3@myune.edu.au