Elective Corporate Governance: Does Board Choice Matter?

Laws can consist of either mandatory or default rules. Yet, there is also the possibility of hybrids between these types of rules. Our paper ‘Elective Corporate Governance: Does Board Choice Matter?’ discusses an example from company law where lawmakers provide different sets of legal rules that users can select (also known as ‘menu laws’). It is based on the finding that, today, many European countries not only allow modifications of a particular board structure, but they provide two separate legal templates by giving firms a choice between multiple board models. How companies actually make use of this availability of board choice is, however, largely underexplored. The project underlying this paper aims to fill this gap. We collected original data about the choice of board models from 14 Member States of the European Union that permit a choice between one-tier and two-tier board models (Bulgaria, Croatia, Czech Republic, Denmark, Finland, France, Hungary, Lithuania, Luxembourg, Netherlands, Romania, Slovenia) and between one-tier, two-tier and audit board models (Italy, Portugal). In a companion paper deriving from this project, we explain the variations in popularity of particular models at the country level in further detail.

It is the aim of the paper presented here to examine the way companies make use of this form of ‘elective corporate governance’ at the firm level: what types of firms make use of which model and whether this choice can be associated with specific financial measures, including the growth of the firm’s operating revenue, Return on Assets (RoA), Return on Equity (RoE), leverage and the cash ratio. For this purpose, we use the technique of propensity score matching, which selects observations from the data so that observations in each treatment group are matched with equivalent observations in the other treatment group. Possibly, this could show that one of the two models has an advantage, at least as far as some of these financial measures are concerned.

Based on the descriptive analysis of the collected data, we find that introducing board choice has led to a gradual decline of the two-tier model. Yet, despite this decline, we did not find that the further empirical results unambiguously speak against the two-tier model. To some extent, we may observe a form of market segmentation as two-tier firms tend to be larger firms favouring a more structured corporate governance. As far as companies have changed their board model with the introduction of choice, we did not find that they performed better than companies that have retained the original model. There are also considerable variations between countries that indicate that board choice is often endogenous to the structure of a particular firm.

Can we draw any normative lessons from this for the desirability of such rules of ‘elective corporate governance’, or, even more generally, the use of ‘menu laws’? We did not find clear evidence that this benefits companies. Of course, absence of evidence is not evidence of absence: thus, some companies may have benefitted from the introduction of this choice. For example, while for many companies, it may not matter what board structure they adopt, companies with internal frictions may be able to benefit from changing their board governance. The general idea of this regulatory approach may also be considered as a plausible one given that both one-tier and two-tier board models have certain advantages. Thus, we suggest that future research could identify other legal topics where a corresponding choice of regulatory models could be implemented.

Martin Gelter is Professor of Law at Fordham University (US).

Mathias Siems is Professor of Law at the European University Institute (Italy).

The full article can be read here.