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E-MailRalph A. Walkling is Christopher and Mary Stratakis Professor in Corporate Governance and Accountability and Founder of the Center of Corporate Governance at Drexel University LeBow College of Business. This post is based on a recent paper authored by Professor Walkling; David Becher, David Cohen Research Scholar and Associate Professor of Finance at Drexel University Lebow College of Business; and Jared Wilson, Assistant Professor of Finance at Indiana University Kelley School of Business.
The modern era has ushered in dramatic changes to corporate governance. While firms used to place celebrities and politicians on their boards, increased demand for specialized expertise and greater scrutiny by regulators, activists, and shareholders all likely motivated firms to alter their boards and demand more from directors. In spite of this, little is known about changes to boards or characteristics of directors selected. In an ideal world, directors should monitor and advise management in an independent manner. However, given shareholders’ limited influence over director selection, it is possible that directors cater to managerial interests in board composition decisions. Our objective is to examine board dynamics and the attributes associated with director selection.
Examining boards of directors from 1996 to 2012, we find that board structure and composition are increasingly stable in the modern era. This stability may be due to a shrinking pool of qualified candidates or director unwillingness to serve under this new environment of increased scrutiny. To better understand board structure decisions, we examine board changes around a specific shock to a firm, mergers. Most prior studies have an incomplete picture of the director selection process as we cannot observe the slate of candidates considered, but not selected. Mergers, however, provide a unique setting to observe a relatively well-defined director labor pool by comparing directors chosen to those that are not. In addition, acquisitions allow us to test ideas consistent with evolving advising and monitoring needs and explore potential conflicts among management, acquirer/target boards and their shareholders, which may impact board structure and composition.
In our paper, we document substantial changes to board structure and compositions around mergers, which are significantly different than for non-merging firms. For example, both director additions and departures are twice as likely around mergers. Of particular note, these changes are not limited to the largest deals (e.g., mergers of equals) as board changes occur across a wide spectrum of deals. Moreover, director additions are highlighted by significantly more unaffiliated directors (neither on the target nor acquirer boards) than retained target directors. The selection of these unaffiliated directors suggests their importance given the pool of available target and acquirer directors considered but not appointed to the post-merger board. These results highlight that board structure and composition are more dynamic for merging than non-merging firms.
We explore three motives for such board changes around mergers: firm need, CEO opportunism, and bargaining. First, changes to advising and monitoring needs associated with increased complexity around a merger may drive adjustments to the board (firm need motive). Second, board changes may occur for managerial welfare reasons as executives seek to establish a more managerial friendly board (CEO opportunism motive). Third, negotiations between acquirers and targets may determine the structure of the post-merger board (bargaining motive). We assess these motives for board changes by first focusing on individual attributes demanded for the post-merger board. Our results show that unaffiliated and target director additions around mergers reflect an increased demand for executive and deal specific skills (prior CEO, merger and board experience). This result is consistent with the notion that the addition of these traits is likely related to the increased monitoring and advising needs of the newly merged firm. Non-merger director selection, however, occurs for routine reasons such as diversity, financial expertise and retirement, suggesting that the drivers of director selection are distinct in mergers.
Next, we capitalize on the unique setting of mergers by comparing the attributes of directors selected to those not selected. Consistent with a firm need motive, directors selected post-merger represent an upgrade in prior CEO, merger and industry experience. Directors added do not appear to have weaker monitoring abilities, inconsistent with a CEO opportunism motive. In addition, target director retention is associated with lower target announcement returns, consistent with bargaining for post-merger board seats. Finally, we examine the tenure of directors following mergers and find that unaffiliated directors are more likely retained for over three years as well as have more CEO-merger and financial expertise than those target directors retained. Collectively, our results suggest that merging firms demand increased monitoring and advising consistent with firm need motives, rather than agency conflicts.
While we document that the motives for board changes and director characteristics demanded around merger are driven by firm need, it is possible that some endogenous factor associated with the motivation to undertake a deal is the underlying driver for these changes. To address this concern, we employ a propensity score matched sample of non-merging firms as well as focus on deals that occur during an industry merger wave, where the motivation to merge may be more exogenous. In addition, we include deal fixed-effects in director-level tests to control for unobservable firm or deal-specific attributes. In all cases, our results hold: board changes and the director attributes associated with selection are consistent with a firm need motive in merger years are significantly different than in the absence of mergers.
Our paper makes several contributions to the ongoing debate over the efficacy of board structure and director selection. We provide a benchmark of board changes in the post-SOX era, which arguably ushered in the most dramatic changes to corporate governance in modern times with increased regulatory demands and scrutiny from proxy advisors and shareholders. While we find increased board stability over time, board changes around mergers are significantly greater and fundamentally different than in the absence of one. Further, director selection associated with the changes surrounding mergers is driven by the nature of a firm, rather than CEO opportunism. These results are particularly important for understanding board dynamics in light of shareholders’ limited ability to nominate or remove directors of their choosing.
The complete paper is available for download here.
