- IMD Business School

The four tiers of conflict of interest faced by board directors

4 min.
May 2017

Conflicts of interest abound at the board level. They constitute a significant issue in that they affect ethics by distorting decision making and generating consequences that can undermine the credibility of boards, organizations or even entire economic systems.

Many corporations require board members to sign a conflict of interest policy at the time of appointment or to declare any conflicts of interest at the beginning of board meetings. Conflict of interest policies normally specify how directors should avoid conflicts of interest. This narrow focus only scratches the surface, given the scope, responsibilities and dynamics of decision making in the boardroom.

The real danger lies in the extent to which boards and directors are unaware of the many subtle conflicts of interest that they are dealing with. The boardroom is a dynamic place where struggles of ego, power, rules, and authority continuously surface, and it is not always clear, in the turmoil of group dynamics, what constitutes a conflict of interest or the manner in which one should participate in board deliberations. Furthermore, director duties tend to diverge from one company to another and from country to country, which adds even more complexity.

In countries with relatively strong shareholder rights, such as in the US, directors are expected to be accountable to shareholders. However, excessive promotion of the interests of shareholders can lead to conflicts with other stakeholders. Due to different contractual arrangements, the interests of stakeholders are often in conflict. Board members are required to always use ethical and appropriate judgment to make seemingly correct choices when conflicts arise.

In many other countries, directors have a duty to the company, not to shareholders. In Germany, for example, the company is considered distinct from the collective shareholders, which prevents shareholders from claiming that the directors have a duty toward them first and foremost. Shareholders are seen as one kind of stakeholder among a pool of many, and the company does not have a duty to maximize shareholder value. Boards are composed of interested directors, such as representatives of employees, shareholders, and other stakeholders. The loyalties of these stakeholder representatives are often divided, and considering that multiple-role directors have to rebalance different interests, the potential for conflict becomes clear.

When the interests of a broader group of stakeholders, such as a government or society, are added to the mix, this judgment goes far beyond what might be included in a written conflict of interest policy. In this article we seek to analyze conflicts of interest as a four-tier pyramid by exploring more and more in depth the conflicting situations, right down to the fundamental purpose of business, in view of helping board directors make better decisions by taking an ethical stand in shaping business in society.

The Four Tiers of Conflicts of Interest

Tier-I conflicts are actual or potential conflicts between a board member and the company. The concept is straightforward: A director should not take advantage of his or her position. As the key decision makers within the organization, board members should act in the interest of the key stakeholders, whether owners or society at large, and not in their own. Major conflicts of interest could include, but are not restricted to, salaries and perks, misappropriation of company assets, self-dealing, appropriating corporate opportunities, insider trading, and neglecting board work. All board members are expected to act ethically at all times, notify promptly of any material facts or potential conflicts of interest and take appropriate corrective action.

Tier-II conflicts arise when a board member’s duty of loyalty to stakeholders or the company is compromised. This would happen when certain board members exercise influence over the others through compensation, favors, a relationship, or psychological manipulation. Even though some directors describe themselves as “independent of management, company, or major shareholders,” they may find themselves faced with a conflict of interest if they are forced into agreeing with a dominant board member. Under particular circumstances, some independent directors form a distinct stakeholder group and only demonstrate loyalty to the members of that group. They tend to represent their own interest rather than the interests of the companies.

Tier-III conflicts emerge when the interests of stakeholder groups are not appropriately balanced or harmonized. Shareholders appoint board members, usually outstanding individuals, based on their knowledge and skills and their ability to make good decisions. Once a board has been formed, its members have to face conflicts of interest between stakeholders and the company, between different stakeholder groups, and within the same stakeholder group. When a board’s core duty is to care for a particular set of stakeholders, such as shareholders, all rational and high-level decisions are geared to favor that particular group, although the concerns of other stakeholders may still be recognized. Board members have to address any conflicts responsibly and balance the interests of all individuals involved in a contemplative, proactive manner.

Tier-IV conflicts are those between a company and society and arise when a company acts in its own interests at the expense of society. The doctrine of maximizing profitability may be used as justification for deceiving customers, polluting the environment, evading taxes, squeezing suppliers, and treating employees as commodities. Companies that operate in this way are not contributors to society. Instead, they are viewed as value extractors. Conscientious directors are able to distinguish good from bad and are more likely to act as stewards for safeguarding long-term, responsible value creation for the common good of humanity. When a company’s purpose is in conflict with the interests of society, board members need to take an ethical stand, exercise care, and make sensible decisions.

Tier-I conflicts: Individual directors vs. company

Directors are supposed to “possess the highest personal and professional ethics, integrity and values, and be committed to representing the long-term interest of the shareowners.” However, in many cases shareholders have sued directors for taking advantage of the company. An actual or potential conflict between a board member and a company is called a tier-I conflict.

A company is normally considered as a separate legal entity that is independent from its directors, executives and shareholders. Powerful directors such as founders or dominant shareholders can be accused of misappropriating company assets if they are found stealing from their own company; directors who trade on the basis of material, non-public information can be sued for insider trading; those caught accepting bribes or working for competing companies may be asked to resign; directors who sign agreements on behalf of the company that mainly contribute to their own enrichment may be charged with self-dealing. For example, the well-known case of Guth vs. Loft Inc. in 1939 addressed the issues of individuals pursuing business opportunities for self-enrichment.

When board members fail to dedicate the necessary effort, commitment and time to their board work, it can result in a conflict between the board member and the company. Directors often serve on multiple boards in order to benefit from several compensation packages. This can often complicate matters for the respective directors, as they may not be able to allocate sufficient time to governing any one company. According to the Spencer Stuart US Board Index 2014, approximately 25% of S&P 500 boards do not impose a limit on the number of board positions. Crainer and Dearlove described that directors who were unable to devote a sufficient amount of their time to any one board, “stuffed the document in their briefcases, all 200 pages or so, and leafed through them in the taxi to the meeting. They extracted, at random, a paper, formulated a trick question and entered the meeting room ready to fire. After all, board work is a power game.” Lack of effort, focus and dedication are types of conflict of interest that have not yet received the attention they deserve.

It is well understood that tier-I conflicts arise when directors take advantage of their positions. However, when directors lack commitment and dedication to their duties, the conflict of interest is somewhat more subtle and much less obvious. Companies need to issue guidelines regarding directors’ conflicts of interest and ensure that directors follow these rules and act in the interest of the organizations they serve.

Companies can self-assess their exposure to tier-I conflicts by asking the following questions:

  1. Has the company experienced situations in which individual directors have taken advantage of the company through compensation, self-dealing, stealing, insider trading, accepting bribes or appropriating opportunities for personal benefit?
  2. How could negligence of board work or lack of commitment present a conflict of interest?
  3. Would signing a code of conduct at the time of appointment be helpful?

Tier-II conflicts: Directors vs. stakeholders

To whom do board members owe their loyalty? This depends very much on law and tradition and the prevailing legal system, social norms or the company’s specific situation. For example, directors might declare that they owe their duty of loyalty to shareholders, the company itself, certain stakeholders or other board members.

The complex institutional loyalty of board directors

In the US, directors often have a duty of loyalty toward the company’s shareholders. The idea of maximizing shareholder value came from Milton Friedman, who proposed that executives and directors should focus solely on creating value for shareholders. Others argue that since the directors and executives are paid by the company, they are employees of the company – not of the shareholders – so they should thus focus on the interests of the company rather than on those of the shareholders.

According to Lynn Stout, a distinguished professor of corporate and business law at Cornell Law School, shareholder value maximization is a choice, not a legal requirement. The assumption that shareholders are principals and that directors are their agents is legally incorrect. Corporate law clearly states that shareholders cannot control directors or executives. They have the right to vote on the positions of the directors of the board and recover damage compensation from directors and executives if they are found to have stolen from the company but they have no right to tell executives how to run the company.

Being loyal to shareholders is, in any case, easier said than done. Shareholders come and go and their interest in the company is limited to their shareholding period. Shareholder’s interests vary depending on their investment horizon, degree of diversification and investment strategy. Given the many types of shareholders, reaching a consensus for all of them is a daunting task. Ordinary individuals and families who invest for their retirement or to fund future expenses are often represented by institutional investors such as sovereign wealth funds, banks, hedge funds, pension funds, insurance companies and other financial institutions. These powerful representatives interact with board members frequently and exercise most of the pressure, but when they put personal interest before that of the ultimate shareholders, interests could be misaligned. For example, the representatives may be striving for short-term personal gain or compensation while the ultimate investors may want the same as all other stakeholders: the creation and preservation of the corporation’s long-term sustainable wealth.

If maximizing shareholder value is a widely accepted norm, then board members would be better positioned if they announced that their loyalty lay with the ultimate shareholders. This would lead them to become stewards of the company and refrain from being distracted by proposals that generate immediate stock returns but endanger the long-term prospects of the company.

A study of directors’ duties in all 27 EU member states and Croatia showed that in Europe directors primarily have a duty of loyalty to their company. This principle is universally accepted and undisputed across the 27 EU countries. All board members, including shareholder representatives, are required to balance the interests of all stakeholders with the long-term prospects of the company. To balance the interests, composition and independence of the board of directors are often defined in the corporate governance codes.

For example, according to the Swedish Corporate Governance Code (applicable from November 1, 2015), “boards of Swedish listed companies are composed entirely or predominantly of non-executive directors. The Code also states that a majority of the members of the board should be independent of the company and its management. At least two members must also be independent of the company’s major shareholders, which means that it is possible for major shareholders of Swedish companies to appoint a majority of members with whom they have close ties.” Even if all directors have a duty of loyalty to their company, most directors serving on the Swedish boards could have close ties with major shareholders, and according to the Code, some directors could have ties with minority shareholders, management, or other stakeholders. The ties with various stakeholder groups potentially create divided loyalties for directors.

The laws of some countries require stakeholder representatives on boards to serve the interests of their respective principals in some situations. For example, banker directors, who are only appointed as board members when a company is in financial distress, must be loyal to their bank, which lent money to the company in question. When the company nears insolvency, the duty to shareholders or to promote the success of the company will be modified by the obligation to act in the interest of the creditors. While it may be perfectly legal for such interested parties to be members of the board, it can help if each stakeholder group puts their ultimate objectives on the table before starting negotiations. This allows minority shareholders and minor stakeholders to have their perspectives heard, which may incite majority shareholders to be more inclined to balance their own interests with those of others.

Influence of domineering board members on others

Both independent and interested directors can potentially be influenced by powerful CEOs, chairpersons or other directors through compensation, favors, relationships or psychological manipulation. Board members may also forsake their institutional duties out of personal loyalty to the CEO or chairperson. One way directors can determine whether they have been overly influenced is by asking themselves, “Have I been influenced or manipulated in order to agree with others?”

Persuasive influence often comes from people holding the combined role of CEO and chairperson as they can sway other board members’ compensation. Even if a board comprises primarily independent directors, it may not be able to remain truly independent from the management. Paul Hodgson, director at BHJ Partners in Portland, Maine, reportedly said about boards that “Shareholders can sit back and say ‘These directors are being paid so well that I can’t see them ever questioning management on anything, because this is a gig they would hate to lose.’” If most of the board members generate a significant total income from board compensation packages, how independent could they be in reality?

Personal, familial and professional relationships can also potentially affect an independent director’s judgment. The social connections between directors and CEOs or chairpersons cannot always be thoroughly checked. For example, retired CEOs may remain chairpersons on the company’s board, and many of the directors on that board may owe the chairperson their job. Or the CEO may invite close friends to join the board as directors. In both cases, the directors in question may be influenced by a sense of loyalty or duty to the chairperson or CEO, even if the CEO or chairperson is not acting in the best interests of the company or its shareholders or other stakeholders. Independent directors would be reluctant to contradict the views of a CEO or chairperson to whom they felt they owed their loyalty, so rather than do so they may either comply or step down from their role.

Boardrooms are dynamic places where heated discussions occur. Those occupying positions of power, such as the CEO and the chairperson, may manipulate directors into agreeing with their preferred decisions using psychological tactics such as tone of voice and eye contact to dominate the discussion, rebuff criticism, or intimidate others for their personal gain. In some cases, board members may feel as though they are being victimized or manipulated while those dominating the discussion may just think that they are leading a dynamic interaction. Such unbalanced dynamics, including superiority and inferiority complexes, reduce the effectiveness of board discussions and prevent independent directors from exercising their duty as directors.

Board directors organized as a self-interested stakeholder group

Regulators and researchers have argued that boards should comprise a greater number of independent directors to ensure that business decisions are not disproportionately influenced by powerful stakeholders. The Spencer Stuart Board Index 2014 survey confirmed that S&P 500 boards elected 371 new independent directors in the 2014 proxy year, a 9% increase from 2013. This followed a 16% increase during the 2013 proxy year.

Independent directors can form a distinct stakeholder group. This happens more often when directors are put in a “survival” mode, in case of financial or political crisis, severe shareholders’ conflicts, hostile takeover or growing tension with management. Such coalitions are growing in power and authority as independent board members increasingly remain loyal to each other in the boardroom, subjugating the interests of the organizations they are supposed to represent to their own. In other words, these stakeholder groups have their own motives and interests and the strategic decisions they make benefit themselves rather than the organizations they are paid to serve.

In certain countries, unless specified otherwise, directors decide what their salary, shares and options will be. If no independent body such as a shareholder committee or a regulator oversees the compensation of directors, this can easily lead to a conflict of interest with the company. In the case of Calma v. Templeton (April 2015), the Delaware Chancery Court in the United States allowed a claim that challenged the directors’ stock compensation from going forward because it was considered “excessive.” The compensation plan limited the number of shares to 1 million per year per participant, which represented a value of US$55 million at the time of the lawsuit. The court determined that the entire decision process for compensation was unfair because the awards to the outside directors were decided by the recipients themselves.

In a 2013 Harvard Business Review article, “What CEOs really think of their boards,” one CEO was quoted as saying, “They like their board seats – it gives them some prestige. They can be reluctant to consider recapitalization, going private, or merging –‘Don’t you know, we might lose our board positions!’ I have been shocked by board members saying, ‘that would be an interesting thing to do, but what about us?’” Another CEO was quoted as saying, “In one situation, we had a merger not go through because of who was going to get what number of board seats… It is still the most astounding conversation of my life.” Rather than steering the company toward long-term value creation, directors who are primarily focused on their own interests tend to lose their objective vision when it comes to making the right decisions for the company. An exceptionally destructive scenario might consist of two stakeholder groups – the executive directors group vs. the independent directors group – leveraging their full control over the board and benefiting one another by building an “I’ll scratch your back if you scratch mine” relationship with both groups continuing to add to their individual compensation at the expense of the company and other stakeholders.

We can see that high compensation does not always have as positive an effect as it was intended to. The more compensation directors receive, the greater their personal desire to be re-elected becomes, so they increasingly focus on remaining on the board, enjoying their status and fame, boosting their compensation further, and obtaining more directorships on other boards.

The structure and level of directors’ compensation varies internationally. According to the German Corporate Governance code, the compensation of supervisory board directors consists of a combination of cash and shares and is linked to individual background and involvement in board and committee functions. At Deutsche Bank, 25% of the directors’ compensation was converted into shares of the company based on the average share price during the last 10 trading days of the year.

In China, not all board members receive compensation from the company they serve. For example, shareholder representatives working full time at the Industrial and Commercial Bank of China (ICBC) receive their compensation from China’s sovereign wealth fund – China Investment Corporation (CIC). This means that state owners oversee the compensation of both executive directors and independent directors, which effectively eliminates the possibility of self-dealing. At ICBC, the modest pay still attracts high-quality independent members to the board, especially those with positive character traits such as conscientiousness, integrity, competence, judgment, focus, and dedication, which cannot be motivated or demotivated solely with money.

  1. In your legal system, to whom do board members owe their duty of loyalty?
  2. Can you define whether in your specific context loyalty to shareholder or loyalty to company is primary? Are there minority shareholders to be concerned about?
  3. If a director claims to owe his or her duty of loyalty to shareholders, would one be able to specify who the shareholders are, i.e. fund managers or activists, large shareholders on the board, minority shareholders not on the board, or the ultimate shareholders?
  4. Can a director be fully independent when the CEO or chairperson decides on the compensation and succession of the directors?
  5. If a director is independent, could you specify who they are independent from (i.e. management, shareholders, other stakeholders, etc.)?
  6. Have you experienced a situation in which domineering directors felt as though they were having a heated discussion while others felt as though they were being suppressed?
  7. Are you aware that directors can form coalitions and leverage their full control of the board to benefit one another in an “I’ll scratch your back, you scratch mine” type of relationship?

Tier-III conflicts: Stakeholders vs. other stakeholders

Directors on boards have another duty: exercising due diligence when making decisions. In Germany duty of care is a legal obligation. The law states that “executive members have to exercise the care of an ordinary and conscientious business leader.” Directors have a fiduciary responsibility to the company from the moment they are recruited, and they are expected to display a high standard of expertise, care and diligence by gathering as much information as possible and considering all reasonable alternatives in order to make sensible decisions.

The trust placed in directors gives them maximum autonomy in decision making, and decisions are not questioned unless they are deemed irrational. This business judgment rule protects directors from potential liabilities, as their decisions are not tainted by personal interest. Though directors are not allowed to act in their own interests, they can promote the interests of a particular stakeholder group against the company, or the interests of one group of stakeholders against another, or they can favor one subgroup over another within the same stakeholder group. It is up to directors to make wise decisions when stakeholders are in conflict.

If a board is composed of interested directors who remain loyal to their respective stakeholders, then it is necessary for stakeholder representatives to cooperate and find the optimal coalition to address common interests. Directors on boards must keep in mind the interests of weak or distant stakeholders to ensure their interests are not overlooked.

Conflicts of interest between stakeholders and the company

A company is an aggregation of stakeholders bound together by economic interest. All stakeholders expect to receive a sizable slice of the pie in exchange for their input. Each group of stakeholders has a different contractual arrangement with the company and distinct motives that means they will be more likely to push for decisions that benefit themselves first and foremost. For example, creditors, such as banks, will prefer the company to play it safe in order to maximize the chances that it will pay off its debt, but this low level of risk taking could hurt the company’s long-term growth potential. At the other end of the spectrum, shareholders can benefit from the successful outcome of a risky project while their losses are limited to the amount of their investment, so they are more likely to encourage risk taking, even if it means putting the company’s survival at risk.

Employees receive cash compensation plus benefits. By negotiating above-average compensation for workers, unions put the profitability of the company at risk. Many companies have gone bankrupt as a result of out-of-control labor costs. In 2008, for instance, workers at GM, Ford and Chrysler were among the most highly paid in the US with over US$70 an hour in wages and benefits once retirement benefits were included in the calculation. This was considerably higher than the average hourly labor costs of US$25.36 for all private-sector workers, and the three car manufacturers were paying about US$30 per hour more than their Asian rivals operating in the US. GM and Chrysler declared bankruptcy whereas Ford Motor Company managed to survive without bailout funds. Eventually, all three recovered by adjusting labor costs to be more or less in line with competitors, which they did by creating private trusts to finance the benefits of future retirees.

As a result of the financial difficulties that many companies encountered during the 1980s and early 1990s, some companies allowed labor unions to designate one or more members of the firm’s board of directors. The first major company in the United States to elect a union leader to its board was Chrysler in 1980. Board members representing unions have a delicate balancing act to play and they need to be aware of the potential conflicts of interest inherent in their role. On the one hand, if they push for high wage increases they could lead the company into bankruptcy and negatively affect all stakeholders in the long run. On the other hand, if they agree to substantial wage reductions they could lose the trust of the workers they are supposed to defend and represent.

Weak corporate governance could open the door for management to take excessive risks. When the bonuses and incentives of top management are linked to quarterly earnings and profits, managers may be more inclined to focus on the short term, which sometimes leads to hazardous environmental and social impacts. BP’s decision to save US$1 million a day by circumventing safety procedures on its Gulf of Mexico rigs is a poignant example of such decisions. The disaster eventually cost the company nearly US$100 billion.

Consumers and customers depend on companies for the reliable supply of products and services. When a company changes its pricing strategy, depending on the product it can potentially have serious repercussions on consumers. In September 2015, Turing Pharmaceuticals raised the price of Daraprim – a 62-year-old drug for the treatment of a life-threatening parasite infection – from US$13.50 to US$750 per tablet. For some patients, treatment became unbearably expensive, and hospitals were forced to use less-effective alternatives to limit costs. Martin Shkreli, the 32-year-old founder, hedge fund manager and chief executive of Turing, said, “This is still one of the smallest pharmaceutical products in the world….It really doesn’t make sense to get any criticism for this.” But in December 2015, Martin Shkreli was arrested for “repeatedly losing money for investors and lying to them about it, illegally taking assets from one of his companies to pay off debtors in another.”

It is challenging for directors to decide which stakeholder group to prioritize when it comes to value distribution and how to slice the pie. In conflict situations, customers can hurt companies, and companies can harm the interests of customers. Closely involved stakeholders such as creditors, employees, top management or shareholders all have motives to push for decisions that benefit themselves but that may potentially hurt the interests of the company in the long run.

Conflicts of interest between different classes of stakeholders

Conflicts can arise between the different classes of stakeholders, e.g. shareholders vs. creditors. Creditors, such as banks, play an important role in corporate governance systems. In some countries, they not only lend to firms but also hold equity so that they can have board representation. In the US, regulations prevent banks from dealing with debt-equity conflicts through equity ownership. With the Federal Reserve’s quantitative-easing program, share buybacks became the preferred way to boost stock prices for the benefit of shareholders. In 2015, S&P 500 index companies returned more money to shareholders through share buyback and dividend payments than they earned. Some of them even borrowed money to pay dividends, which represents a direct transfer of value from creditors to shareholders since a higher level of debt increases the probability of default and reduces the value of the creditor’s stake. An extreme example to illustrate this is that a company can borrow money, then sell all its assets to pay shareholders a liquidating dividend, leaving creditors with a worthless business.

Executives may sometimes take part in controversial activities in the name of shareholders’ interests. Lou Gerstner had a record of fixing ailing companies and was credited with rescuing IBM through tough decision making, including massive layoffs. One major change took place in 1999, when IBM overhauled its pension plan under Gerstner to help cut costs, shocking long-term employees. In 2002 Gerstner ended his tenure at IBM with an annual salary of over US$1.5 million, an annual pension of over US$1.1 million and over US$288,000 in deferred compensation in 2001 alone. IBM employees later filed a class-action lawsuit over the pension changes, and in 2004 the company agreed to pay US$320 million to current and former employees in a settlement. If an executive’s compensation is linked to cost savings on the back of employees, the two groups are considered to be in conflict of interest.

Even when executives proclaim that they are dedicated to the interests of shareholders, the fact that they try hard to minimize shareholder involvement in corporate governance shows that there is a conflict of interest between the two groups. As Steve Pearlstein wrote in The Washington Post in 2013, “This blatant hypocrisy is most recently revealed in the all-out effort by the business lobby to prevent shareholders from voting on executive pay or having the right to nominate a competing slate of directors.” The same year, the Swiss population passed a referendum “against corporate rip-offs,” which allowed shareholders to control the salaries of executives. A majority of 67.9% of voters supported the reform, which stipulated that the shareholders of all Swiss public listed companies must elect all the members of a company’s remuneration committee, and all directors are subject to annual re-elections.

Supporters spent CHF 200,000 to put forward the initiative, while opponents spent CHF 8 million trying to block it. This Swiss referendum was one of the first social responses to the conflict of interest between executives and shareholders. The initiative was launched by businessman Thomas Minder, whose own story illustrated how entrenched executives could damage all other parties to benefit themselves. Minder’s company, Trybol, supplied cosmetics to Swissair. It suffered significant losses when Swissair went bankrupt in 2001 due to a failed expansion strategy. Before the bankruptcy, it was made public that Swissair’s top executive was to receive a golden parachute totaling CHF 12.5 million. Minder was so irritated that he started the anti-rip-off initiative.

Could certain stakeholder groups, such as management, creditors, or shareholders benefit specifically from corporate decisions that could potentially hurt the other stakeholders? This is apparent when the value increase for one class of stakeholders is directly linked to the value reduction of another class of stakeholders.

Conflicts of interest within a group of stakeholders

In closely held companies, large shareholders can exploit minority shareholders by leveraging their control power. More often, directors are influenced by the controlling shareholder sitting on the board. Their directorship as shareholders, preference for capital structure, dividend policy, and investment strategy, or their position with regard to mergers and acquisitions might be in conflict with other shareholders.

In 2015 Volkswagen AG’s supervisory board comprised 20 members, with only one independent director. The founding Piëch and Porsche families co-dominated the board in alliance with unions and the government. Volkswagen chairman Ferdinand Karl Piëch, the grandson of Ferdinand Porsche (Porsche founder), leaked the following comment to the press without the board’s knowledge: “I am distancing myself from Winterkorn (Volkswagen CEO).” These six words further inflamed a decades-long battle between the two shareholding families behind Volkswagen and Porsche. Ferdinand Karl Piëch probably instigated this tension with the intention of extending his influence as a controlling shareholder. But during the shareholder showdown, Winterkorn won the support of the Porsche family, the labor leaders and the state of Lower Saxony. After losing the battle, Ferdinand Karl Piëch resigned as chairman of Volkswagen AG. However, before long Martin Winterkorn found himself having to resign amid the VW emissions scandal in September 2015.

The Volkswagen case shows that it is difficult for a board to optimize the interests of shareholders when they have conflicting interests. In practice, when most directors on boards are shareholders or stakeholder representatives, infighting becomes a common issue. Minority shareholders are vulnerable when the controlling owner attempts to squeeze out the other shareholders, for example by buying, selling or leasing assets at non-market prices, as a way to shift corporate resources to the large owner.

Conflicts within one group of stakeholders are not limited to shareholders. Creditors on boards could have an unfair advantage over other creditors in that they could use insider information to shield themselves from potential trouble and hurt other class of debt holders, especially when the firm is in financial distress.

The following is a checklist of tier-III conflicts of interest:

  1. Why is a key stakeholder group pushing for decisions that may benefit themselves but potentially hurt the interests of the company in the long run?
  2. How can the pie be divided when there are conflicts of interest between the different classes of stakeholders, such as shareholders vs. creditors, executives vs. employees, or executives vs. shareholders?
  3. How can conflicts of interest between subgroups of one particular stakeholder group be dealt with?
  4. How can a director make a wise decision when stakeholders have conflicting incentives and goals?

Tier-IV conflicts: Company vs. society

The way a company views its purpose will affect its notion of responsibility, accountability and how it creates value. The ethical behavior of executives has deep roots in Western ethical traditions. Discussions on business ethics have been ongoing since the market economy emerged more than 750 years ago. In general, company and society are not in conflict: Corporations contribute to society by inventing new technologies, fulfilling consumers’ demands for goods and services and creating jobs; society creates the conditions that allow companies to harness their potential for the common good of humanity.

In 1981 Business Roundtable, an association of chief executive officers of leading US companies working to promote sound public policy, stated that “Corporations have a responsibility, first of all, to make available to the public quality goods and services at fair prices, thereby earning a profit that attracts investment to continue and enhance the enterprise, provide jobs, and build the economy” and that, “the long-term viability of the corporation depends upon its responsibility to the society of which it is a part. The well-being of society also depends upon profitable and responsible business enterprises.” Initially executives accepted this definition of the responsibilities of companies but their stance changed dramatically when in 1997 the Business Roundtable redefined the purpose of a corporation in society as being “to generate economic returns to its owners” and that if “the CEO and the directors are not focused on shareholder value, it may be less likely the corporation will realize that value.” It became a duty for board members to admit that the sole purpose of corporations was to maximize shareholder value.

If not managed properly, maximizing returns for shareholders – for example by deceiving customers, defaulting on payments to creditors, squeezing suppliers and employees and evading taxes – can strip value generation from other stakeholders. Indirect harmful effects on society include shaping the rules of the game (e.g. lobbying to change a law, tax rules, accounting rules, subsidies, etc.), pollution, market manipulations through collusion, or limiting the opportunities for future generations to improve their lives. Such behavior may well increase payoffs to shareholders in the short term but it can only lead to the eventual demise of the corporation and total destruction of long-term shareholder value. The only class of stakeholders that benefits from this short-term value maximization exercise are chief executives enjoying high compensation, severance packages and golden parachutes. According to Fortune, the average tenure of CEOs in the 500 largest companies in the US is 4.9 years. When a CEO believes they could be dismissed at any time, they may be more inclined to take decisions that maximize their own income in the short term in the name of maximizing shareholder value. If all CEOs behave in this manner and boards of directors allow it, companies will end up doing more harm than good to society.

In a study of stewardship, companies potentially ranking highly in stewardship used a broad vocabulary to describe their relationships with other stakeholders in their 10K reports – words including air, carbon, child, children, climate, collaboration, communities, cooperation, CSR, culture, dialog, dialogue, ecological, economical, environment, families, science, stakeholder, transparency and well-being. This mirrored their long-term approach to building rapport with local communities and the broader society.

By comparison, companies potentially ranking low in terms of stewardship used words like appeal, arbitration, attorney, attorneys, claims, court, criticized, defendant, defendants, delinquencies, delinquency, denied, discharged, enforceability, jurisdiction, lawsuit, lawsuits, legislative, litigation, petition, petitions, plaintiff, punitive, rulings, settlement, settlements, and suit. This indicates that companies rarely benefit from bad actions in the long run, as cost will come back to the company in the form of litigation, sanctions, fines or public humiliation.

The aftermath of the 2008 financial crisis demonstrated that greed does not pay. From 2008 to 2015, 20 of the world’s biggest banks paid more than US$235 billion in fines for having manipulated currency and interest rates and deceived customers. For example the Bank of America alone paid approximately US$80 billion while JP Morgan Chase paid up to US$20 billion. These fines were expected to deter further wrongdoing and to change corporate culture.

Society and various stakeholders place their trust in board directors to run companies and they hold them accountable for doing so. Directors need to understand that a company cannot prosper if it is in conflict with society, and that since they have the power and authority to recruit, monitor and support management, they are on the front line when it comes to changing the company’s culture from having a short-term focus to considering the long term when resolving potential conflicts between the company and society.

Self-assessment questions to ponder with regard to this last dimension include:

  1. Why does your company exist?
  2. How does it create value?
  3. Is your company a contributor or a value-extractor in society?
  4. Do you have the courage to take an ethical stand when your company is in conflict with society?


A company is the nexus that links the interests of each stakeholder group within its ecosystem. The board is the decision-making body and its successes and failures are determined by the ability of its board directors to understand and manage the interests of key stakeholder groups. It is not an easy task to balance the interest of different stakeholders when shareholders are the ones who put money and often more visible and demanding. There is no “one size fits all” solution to corporate governance issues, and there is no straightforward answers to manage all the conflicts of interest given the unpredictable nature of firm and business environment contexts, boardroom dynamics and human behaviors. In principle, decisions at the board level should be ethical and reasonably balanced.

Boards need to have a specific policy in place for dealing with tier-I conflicts of interest between individual directors and the company. This policy needs to specify processes for dealing with major actual and potential conflicts, such as misappropriation of assets; insufficient effort, focus and dedication to board work; self-dealing and related transactions; insider trading; and taking advantage of corporate opportunities in an open and transparent way. If possible, the policy should be signed by all directors and updated regularly, and conflicts of interest should be declared at each board meeting. The control mechanisms could be institutionalized. ICBC’s supervisory board is composed of five to seven stakeholder professionals and some of them are full-time on-site supervisors. By attending board meetings as non-voting delegates, ICBC’s board of supervisors is able to monitor the performance of directors and senior management, auditing processes, and overall activities and decisions that affect the company in the short and long term. Monitoring is based on several criteria, such as work attitude, behavior, capacity to fulfill duties, contribution, and so on. In addition, retiring and leaving directors, presidents and other senior management members have to undergo an auditing process by the board of supervisors. This type of institution is rarely seen in Western countries, so a similar and feasible solution is to allow external auditors to play a role here.

To deal with tier-II conflicts, directors need to disclose their relationship with stakeholders. This gives them an opportunity to declare in advance who they represent. Even if the law requires all directors to represent the interests of the company, identifying their connections with specific stakeholder groups improves transparency and avoids the risk of conflicts of interest. It is also crucial to specify who nominates new directors, who decides on directors’ compensation, how the pay structure and level are determined, and how pay is linked to performance and function. In performing their duties, all directors need to put aside their ego, follow rules in discussions, respect others, and avoid toxic behavior in the boardroom. Coalitions can be beneficial when they are aimed at acting in the best interest of the company, but they can be harmful when they are formed with the aim of dominating the board or benefitting a particular stakeholder group.

Tier-III conflicts of interest can be minimized when directors and boards “slice the company pie” properly in an effort to support cooperation and avoid inducing sabotage, riots, retaliation, fines, in-fights or legal actions. Wise decision making requires understanding deep-rooted conflicts between stakeholders and the company, between different stakeholder groups, and between subgroups of one stakeholder group. No company can survive without the input of each stakeholder group: responsible shareholders, understanding debt holders, innovative employees, satisfied customers, happy suppliers, great products and services, friendly communities as well as effective and efficient government.

Tier-IV conflicts between the company and society are philosophical. Solving them requires directors to act as moral agents and be able to distinguish “good” from “bad.” Do companies compensate stakeholders because they are useful, because they are protected by law? Or do they do so because stakeholders contributed to the success of the company? Should companies consider the interests of future generations who have not directly contributed to profitability and who are not represented on the board? Should companies make corporate sustainability investments because they are popular, because they portray the company in a favorable way and increase profitability in the long run, or because they are a way to show true gratitude?

Good governance starts with the integrity and ethics of every director on every board. Board directors have a moral obligation not to take advantage of the company, but to be loyal to the company, make wise decisions, neutralize conflicts among stakeholders, and act in a socially responsible way. An ethical board sets the purpose of the company, which in turn influences all dealings with stakeholders. The four-tier pyramid summarizing the different levels of conflict of interest can help board directors anticipate and identify potential conflicts, deal with conflicts and make sensible decisions to chart a course for the future of the company.


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