Do Director Elections Matter?

Vyacheslav Fos is Assistant Professor of Finance at Boston College Carroll School of Management. This post is based on a recent paper authored by Professor Fos; Kai Li, W.M. Young Chair in Finance and Professor at the University of British Columbia Sauder School of Business; and Margarita Tsoutsoura, Associate Professor of Finance and Charles E. Merrill Scholar at the University of Chicago Booth School of Business. Related research from the Program on Corporate Governance includes The Costs of Entrenched Boards by Lucian Bebchuk and Alma Cohen; and How Do Staggered Boards Affect Shareholder Value? Evidence from a Natural Experiment by Alma Cohen and Charles C. Y. Wang.

Modern corporations are characterized by the separation of ownership and control. Members of a corporate board are tasked to monitor managers. For board governance to be effective, shareholders must have a mechanism for disciplining directors. The shareholders’ right to elect directors is therefore a fundamental feature of corporate governance. Despite that feature’s importance, evidence that director elections matter in aligning directors’ incentives with those of shareholders is limited.

In our new research, Do Director Elections Matter?, we aim to isolate the role of the director election process in aligning directors’ incentives with those of shareholders by introducing a novel measure of director proximity to elections—Years-to-election—and thereby examine whether and how director elections matter, using CEO turnover as our focal corporate event. Our new measure is motivated by the political business cycle literature (e.g., Rogoff and Sibert, 1988; Alesina and Paradisi, 2015) and allows us to capture how electoral incentives affect director decisions. For each director-year, Years-to-election is the average number of years from a given year to the next election across all of a director’s board seats.

Using a large and comprehensive sample of director elections and CEO turnover cases over the period 2001–2010, we examine the relation between director elections, firm performance, and CEO turnover. We find that the closer directors of a board are to their next elections, the higher their firm’s CEO turnover–performance sensitivity. In terms of economic significance, a one-standard deviation change in board Years-to-election is associated with a 15% change in CEO turnover–performance sensitivity.

We further show that not all board members matter equally: Years-to-election of the Chairman of the Board (COB) and members of the nomination committee have more influence on CEO turnover–performance sensitivity relative to other board members. Moreover, we find that for firms with a separate CEO and COB, there is a significant effect of board Years-to-election on CEO turnover–performance sensitivity, whereas for firms with a common CEO and COB, this effect is entirely lacking.

The challenge involved in empirically identifying a causal effect of board Years-to-election on CEO turnover policy is the possibility that an omitted variable is driving the relation between board Years-to-election and CEO turnover policy. We perform a series of tests to support a causal interpretation of our main results.

First, we require all sample directors have had tenure for at least three years. This requirement mitigates the concern that our results might be driven by directors who join a board around the time of a CEO turnover event. With every director having now experienced at least one election cycle prior to the turnover event, it is highly unlikely that the timing of a director’s joining the board will affect our results. We find no material change in the results.

Second, to provide further support for a causal interpretation of the relation between board Years-to-election and CEO turnover–performance sensitivity, we repeat the analysis using each director’s Years-to-election on other boards as a measure of her proximity to elections. As such, it is less likely that the variation in the Years-to-election measure due to other boards is related to factors that influence the CEO turnover decision in the event firm. We find no significant change in the results, supporting a causal interpretation.

Third and finally, we show that our results are not driven by director self-selection into firms with staggered boards that prior work has shown are associated with poor corporate governance practices (e.g., Bebchuk and Cohen, 2005). For this test we limit the analysis to firms with unitary boards and to directors who serve on those boards and on one additional staggered board. In this case, the directors in the sample have chosen the same number of board seats involving both a unitary and a staggered board, suggesting that they have the same level of preference for staggered board seats. Moreover, the variation in the Years-to-election measure comes entirely from other (staggered) boards. Our main findings remain, which provides additional support for a causal interpretation.

We next explore possible explanations for our findings. We begin by showing that shareholders do pay attention to director elections. There is increased media coverage of directors closer to their elections, especially when their firm has experienced poor performance. Next, we show that directors of firms with CEO turnover events are more likely to retain seats both on the event firm board and on other boards relative to a sample of matched directors (on director age, number of directorships, and firm performance) whose firms do not experience CEO turnover events. It is therefore plausible that because there are labor market rewards for disciplining CEOs, directors who are closer to elections (and hence are more exposed to their labor market) are more eager to fire CEOs after poor firm performance. Finally, we show that firms with CEO turnover events are less likely to receive negative recommendations for voting in director elections from proxy advisory firms relative to a sample of matched firms with similar performance that do not experience CEO turnover.

We offer some suggestive evidence and discussion on the governance role of director elections. We show that firms with more long-term-oriented institutional investors and hence more institutional monitoring exhibit higher CEO turnover–performance sensitivity in the same way as board Years-to-election, suggesting that the pressure from board members induced by their closeness to elections does not necessarily lead to myopia. In terms of performance implications of board Years-to-election, we show that when directors are closer to elections, firm performance improves.

We conclude that director elections have important implications for corporate governance.

The full paper is available for download here.

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