Globalizing the Boardroom

In the paper, Globalizing the Boardroom – The Effects of Foreign Directors on Corporate Governance and Firm Performance, forthcoming in the Journal of Accounting and Economics as published by Elsevier we examine independent directors of U.S. firms who are based in foreign countries, and investigate how their geographic location affects their ability to perform their monitoring and advisory duties. About 13% of U.S. firms have foreign independent directors on their boards. On the positive side, FIDs can utilize their international background and expertise to enhance the advisory function of boards and benefit firms with substantial foreign operations or plans for overseas expansion. On the negative side, the geographic distance between FIDs and corporate headquarters, as well as national borders with passport and custom controls create significant obstacles for FIDs to effectively participate in the governance of U.S. firms.

Our analysis of specific actions undertaken by directors and corporate policies they help formulate indicates that FIDs bring both benefits and costs to the firms they serve. Specifically, we find that firms with FIDs make better cross-border acquisitions when they pursue targets from the home regions of FIDs, evidence of the value added by FID expertise. However, we also find that FIDs are more likely to miss board meetings than domestic independent directors, and that firms with FIDs pay their CEOs excessively high compensation, are more likely to engage in intentional financial misreporting, and are less responsive in replacing poorly performing CEOs. These findings point to the monitoring deficiencies of FIDs and suggest that they undermine the effectiveness of board oversight and contribute to more managerial slack and misbehavior.

We next evaluate the net effect of FIDs on firm performance. Our results show that firms with FIDs exhibit significantly poorer performance, especially when they do not have significant business presence in the FID’s home region, consistent with costs of FIDs outweighing benefits in such instances. But, as firms generate a higher percentage of total sales from their operation in the FID’s home region, they derive more benefits from FID expertise. We also find that the announcements of FID appointments elicit significantly negative stock market reactions, signaling shareholder skepticism about FID contributions to firm value. Overall, our findings call for a balanced approach toward the hiring of foreign independent director by U.S. firms, and suggest that a careful cost-benefit analysis is warranted in such decisions.

The same considerations should also apply to non-U.S. firms. Companies from countries with weak investor protection may benefit from appointing outside directors from countries with stronger investor protection as a way of improving board monitoring and overall corporate governance. However, given the obstacles faced by foreign directors as accentuated by our study and the experiences of Korean companies, it is unclear if the expected benefits outweigh the expected costs. Further research on this issue is clearly needed. In the short run, any foreign director appointment decision needs to be well thought out, since it may have the unintended negative consequence of weakening corporate governance rather than strengthening it.

The full paper is available for download here.