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E-MailThe following post comes to us from Olubunmi Faleye of the Finance Department at Northeastern University, Rani Hoitash of the Department of Accountancy at Bentley University, and Udi Hoitash of the Accounting Department at Northeastern University.
In our paper, Advisory Directors, which was recently made publicly available on SSRN, we study the characteristics and effects of directors dedicated to providing strategic counsel to the chief executive officer (CEO). The question of how to structure corporate boards for effective oversight of top management has attracted significant academic and regulatory efforts in recent years. In contrast, how best to structure the board for optimal advising remains an important but much less investigated topic.
In an attempt to bridge this gap, we propose that the board’s advising functions are best performed by a distinct class of independent directors minimally involved in monitoring management. Specifically, we define an advisory director as an independent director who does not serve on any of the principal monitoring committees but serves on at least one advisory committee if the company has any. We argue that such directors are best positioned for effective advising because their minimal involvement in monitoring enables them to develop a trusting relationship with the CEO and provides the time needed to focus on strategic issues. This facilitates information exchange with the latter, makes him more likely to seek their opinions, and provides a friendly sounding board for important strategic proposals.
We test our hypothesis using a sample of over 4,000 companies during 2000–2009. Focusing on acquisition performance, corporate innovation, and firm value, we find that advisory directors are associated with better acquisition returns, shorter time to deal completion, increased corporate innovation, and higher firm value. We also find that the positive value effects are greater when the company has greater advising needs and when the CEO is more amenable to board influence on strategy.
These results illustrate the importance of directors’ advisory role in governance effectiveness. Yet reform efforts and the adverse publicity of monitoring failures have tended to shift directors away from strategic advising and toward managerial oversight. Heidrick & Struggles (2007) report that 84% of directors in its survey indicated that “to at least some extent they are now spending more time on monitoring and less on strategy.” Faleye, Hoitash, and Hoitash (2011) show that such intense focus on monitoring is detrimental to overall board effectiveness, concluding that “the desire for more intense monitoring must be balanced against the need for directors to advise management and the benefits of a supportive board that reduces managerial myopia and risk aversion.” The structure we propose provides an avenue for achieving this balance by explicitly dedicating some directors to board advising.
The full paper is available for download here.
