MANAGERIAL ENTRENCHMENT

Professor Joanne Horton

By Joanne Horton

What are the dynamics through which corporate boards fail? While the corporate governance literature examines the relations between board composition and financial performance, it pays little attention to how exactly such relations unfold.

We aim to address this question by examining one of the Irish banks embroiled in the Irish banking crisis of 2008-9—Anglo Irish Bank (hereafter, Anglo). We study the case of Anglo and examine, using interviews with key individuals involved in the bank, the dynamics on the board and among other managers, paying particular attention to relations between the board and Anglo’s CEO. Our choice to study Anglo was motivated by the fact that Anglo embodied dramatically a corporate failure: a bank that in less than 20 years moved from being a spectacular success, to collapsing, requiring the highest bailout to date from the Irish government.

Anglo was formed in 1986, and concentrated almost exclusively on lending against commercial property and asset finance on a secured basis. Anglo saw significant growth in both its profitability and market capitalisation. In 2007, it reported profits of €1.221 billion up 44% on the prior year and its share price peaked at €17.53, significantly outperforming all the other Irish banks. But just one year later, in 2008, with the drying up of global credit markets and the bursting of the Irish property bubble, Anglo’s share price collapsed. The then chairman, CEO and a NED were all forced to resign over a governance indiscretion relating to director loans. By January 2009 Anglo was fully nationalised by the Irish Government. The total cost of the government bailout of Anglo exceeded €34 billion.

Recent academic research relates corporate failures, such as the ones that took place during the Irish banking crisis, to organisational and behavioural dynamics on and around corporate boards: poor risk management, personality traits such as over confidence and hubris among senior executives and biases in judgement and decision making. Whilst this emerging literature indicates an important direction for investigation, it also tends to focus primarily on how each of these single factors affected the resulting failure.

In contrast, our research paper indicates that it is necessary to analyse the interrelated nature of the dynamics so as to explore the web of conditions that enable and encourage corporate weakness and failure. Following this, we make two propositions. First, we propose that a dominant CEO would affect the composition of the board and contribute gradually to a formation of board strongly characterised by high degree of homogeneity and social cohesiveness. This, in turn, is related to lack of experience and to low motivation to scrutinise managerial decisions. Second, the combination of a dominant CEO and the highly socially-cohesive board populated by CEO-friendly members also serves as a ready infrastructure for the evolvement of norms that signalled managerial stock ownership not as a motivating device but as an indication of loyalty to the company. These dynamics would be intensified further by broader organisational dynamics, especially the practices reflecting and intensifying a belief in a managerial and strategic superiority and norms demanding repeated defence of this belief.

Our research finds that Anglo’s high degree of social cohesiveness contributed to emergence of informal but well adhered to norms that aimed at marginalizing and silencing, in effect, actors, internal as well as external, that expressed dissenting views to those of the CEO or others in Anglo. This growing intolerance to criticism in Anglo played an important role in the emergence of beliefs and practices that regarded stock ownership as a signal of loyalty to the board and the company rather than, as the literature commonly predicts, an incentive for improving managerial performance. For example, an Anglo board member explained that “I can tell you for a fact that I did not sell my shares, […] even at that point when I knew things were in trouble […] I felt it would be inappropriate for me to sell them and if I was seen to be selling them”. A different board member noted that selling shares by senior managers was not “particularly well appreciated” unless the seller provided an explanation. This evidence is supported by the fact that despite a significant drop in share price early in 2007 all of Anglo’s directors continued to increase their holdings, until the collapse of the bank at the end of 2008.

Ultimately our paper informs the debate in the corporate governance literature about how stock ownership among directors affects financial performance and sheds new light on the entrenchment hypothesis. The entrenchment hypothesis assumes a curvilinear relationship between managerial ownership and performance: up to a certain point, more shares owned by managers lead to improved performance, but beyond that point, negative practices begin to emerge, leading to inferior performance and even collapse. The hypothesis, however, does not provide a set of conditions necessary for such reversal of impact to take place. Our examination indicates that dynamics at the board level and at wider intra-organisational circles are related to managerial entrenchment. At the board level, a strong CEO with a record of success spearheaded a process that led to a skills-impoverished board. More broadly, a set of normative practices that linked loyalty with ownership, and with desirable behaviour in general, were promoted and even imposed on managers and employees. For example, whilst non-entrenched managers may regard personal ownership of shares as a cause for additional caution and responsibility, entrenched managers, being exposed to a domineering CEO may see ownership as signal of loyalty, and such, demand it from top managers. The phenomena at both levels can help us to develop, for future research, hypotheses about the changes in interpretations and meanings given to ownership—the core of managerial entrenchment.

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