Intellectual Capital, Corporate Governance, and Firm Value

Previous empirical studies on the benefits of “good” governance perform comprehensive and detailed analyses of corporate governance structures and regulations, but make no reference to the board’s intellectual capital, or knowledge, thereby substantially limiting the understanding of the role of corporate governance in organizational value creation. In the paper, Intellectual Capital, Corporate Governance, and Firm Value, which was recently made publicly available on SSRN, I address this gap.

I use the number of scientists on the board of directors as a proxy for the board’s intellectual capital and investigate the impact of directors-scientists on firm value in the population of publicly-listed U.S. firms. I expect a positive contribution of scientists to firm value in knowledge-intensive sectors, such as information technology, pharmaceuticals and chemical products, characterized by significant R&D activities, product innovation, and long-term projects. Boards with strong scientific expertise are more likely to make effective strategic R&D decisions and subsequently monitor these decisions effectively than boards with limited scientific experience. Directors with scientific background are also expected to have a longer decision horizon than other directors; the boards with strong scientific expertise are therefore more likely to select long-term projects that maximize the firm’s net present value instead of the projects that focus on current profits.

Consistent with the predictions, I find that scientists on the board of directors have a positive impact on firm value in knowledge-intensive sectors. The number of scientists on the board significantly increases the firm’s Q. Furthermore, the appointments of scientists to the board of directors lead to positive stock returns in knowledge-intensive sectors. The news of the nomination of a scientist to the board increases the stock price in a three-day window around the announcement by 1%, on average, while the 12-month post-event period is characterized by a positive abnormal return of up to 2.5%. I do not observe similar impact in other industries.

In sum, the results suggest that scientists on the board of directors constitute a significant asset and a driver of superior performance in knowledge-intensive industries. On a more general level, the findings highlight that the board’s intellectual capital is an important dimension of corporate governance and a source of organizational value creation. The main contribution of this study to academic literature is therefore threefold. First, this study bridges the gap between research on the firm’s intellectual capital and research on corporate governance. Second, this study provides a new extension to the long line of research on the impact of corporate governance on firm value and investor reaction to changes in board structures. Third, this study highlights the importance of controlling for contextual factors, such as industry-specific effects, in corporate governance research.

The results also have significant practical implications. From the perspective of investors, the evidence of short-term and long-term stock returns following nominations of scientists to the board suggests that the market recognizes the value-added of directors-scientists in knowledge-intensive sectors but appears to underreact to the news of director nomination. From the perspective of corporate governance practices, the firms in knowledge-intensive sectors that have no scientists on the board of directors should assess the expected benefits of appointing directors-scientists to the board. Currently, 60.5% of the firms in knowledge-intensive sectors have no scientists on the board. While this research does not suggest that corporate boards should be entirely staffed by scientists, it clearly indicates that the presence of scientists on the board has, in general, a positive impact on firm value.

The full paper is available for download here.