Insiders and Outsiders in Corporate Governance

Thearticles of incorporation of all profit-making firms hold a lot ofsignificance in profit making thus, these firms structure incentivesto maximize profits rather than settle stakeholder interests. In thisregards, this structure has an external and internal aspects to themanagement of the firm with the Board of Directors assuming thedefinitive corporate authority (Joseph, Ocasio, &amp McDonnell,2014). Although the board has a fiduciary duty to advance thewelfares of the stakeholders, its main duty is to maximize financialgain thus, it does not advance non-financial welfares ofstakeholders. In addition, the board does not advance any welfare ofthe stakeholder whether financial or not, that does not ground onpossession of stock in a firm. On the other hand, the principal-agentproblem that exist within a firm may and usually inhibits the profitmaximization objective of the directors since employees are usuallytempted to divert resources to their individual goals.

Againstthe backdrop of the highlighted issues, it is important to discussthe composition of the Board of Directors as well as note whether itadvances stakeholder behavior or neoclassical behavior. Thecomposition of a Board of a Directors is an important facet in theadvancement of a firm’s objectives and the issue of whetherinsiders (senior managers of the firm sitting in the board) oroutsiders should have more power has become a foremost discussion forfirms today. Iliev, Lins, Miller, &amp Roth (2015) and Berndt (2013)opine that a good number of policy makers believe that outsidersshould embrace the balance of power but some researchers agree thatboth outsiders and insiders should have corresponding balance ofpower. In fact, most academician recommend that outsiders should holdmore power and have a larger number than insiders since outsiders’impartiality must overcome the self-interest that can conflictinsiders (Iliev et al., 2015). However, opponents of outsidersholding more power opine that the board may end up lacking adequatefirm-explicit knowledge, which may diminish the performance of afirm.

In this regards, it is imperative to align the composition of aboard to the diversification of a firm. In fact, the level ofdiversification in a firm determines the success of a board to alignthe objectives of the management with those of the stakeholders. Inaddition, the form of internal control chosen is an important elementin composing board. Joseph et al. (2014) and Esqueda (2015) opinethat firms that utilize strategic controls assess themselves byutilizing idiosyncratic standards and decision that center on theoperational facets of the approaches thus, the board shouldunderstand fully the firm’s operations and markets. In addition,strategic controls require insiders and outsiders to exchangestrategic knowledge thus, this form of control should have abalanced composition. Conversely, firms utilizing financial controlsdepend on on objective standards, for instance, return on investment,for assessing performance (Berndt, 2013). These firms should enjoy ahigh level or magnitude of autonomy for them to advance performancethus, financial control is suitable for outsiders. In this regards, agreater power of the outsiders means that managers cannotover-diversify to increase their compensation or diminish theiremployment risk. On the other hand, insiders play a key role in firmsthat wish to have strategic controls since by profferingfirm-detailed information and strategic emphasis, they ensure thatoutsiders emphasize on both financial and strategic issues.

As detailed in the discussion, the composition of a board is animportant facet in the contemporary business. Researchers assert thata firm should have outsiders with an upper hand in the control toensure profit-maximization (Esqueda, 2015). Firms with diversifiedportfolios can have balanced power between insiders and outsiders.However, a balanced power does not mean equal numbers of directorsfrom both sides but rather equal power. As such, a board’s balanceof power should rest with the outsiders.

References

Berndt, M. (2013). Global differences in corporate governancesystems: theory and implications for reforms. Springer-Verlag.

Esqueda, O. A. (2015). Signaling, Corporate Governance, and theEquilibrium. Journal of Finance, 55, 565-613.

Iliev, P., Lins, K. V., Miller, D. P., &amp Roth, L. (2015).Shareholder voting and corporate governance around the world. Reviewof Financial Studies, hhv008.

Joseph, J., Ocasio, W., &amp McDonnell, M. H. (2014). The structuralelaboration of board independence: Executive power, institutionallogics, and the adoption of CEO-only board structures in US corporategovernance. Academy of Management Journal, 57(6), 1834-1858.