Director Networks, Turnover, and Appointments

Luc Renneboog is Professor of Corporate Finance at Tilburg University and Yang Zhao is Lecturer in Banking and Finance at Newcastle University. This post is based on a recent paper by Professor Renneboog and Professor Zhao.

A company’s shareholders are to elect or approve the appointment of the non-executive (or supervisory) directors whose fiduciary duties include monitoring the CEO and the other executive directors. In case of continued poor corporate performance or natural retirement, one of the key responsibilities of the board is to contemplate the dismissal of the underperforming executives and to appoint successors. In this context, both networks of the executive and non-executive directors are likely to play an important role; the network of the former can facilitate the search for a new position in another firm, while the latter connections yield information on the pool of (external) successors. The role of social networks in job-searching has been well studied in sociology and labor economics for laborers and employees belonging to minorities, but has not been examined intensively for corporate top management. Given that close professional and social connections exist among the corporate elites, it may well be that executive and non-executive director networks are even more important in a labor market context than employees’ connections. Contrary to many existing studies that only focus on the CEO turnover, we evaluate the turnover and succession of all board members, comprising the CEO, executive directors, chairmen and non-executive directors.

In our paper (where we use the UK definition of director—he can be either executive or non-executive), we address the question: “To what extent do director networks affect the top managerial labor market?” and focus on two types of connections in director networks, namely direct and indirect connections. The former type comprises connections between directors who are linked with one another via shared work experience and directors gain access to local information from direct connections. Indirect connections capture that directors can be connected to important directors who are themselves connected to many other directors, are hence able to collect much information from the whole network of directors of listed firms, and can hence be regarded as intermediaries in information gathering. Directors with superior indirect connections may acquire a global information advantage. We embed the social network methodology into our analysis of this labor market at the director level and focus specifically on the following issues:

First, We examine whether, through his corporate network, a director may be able to obtain information about which firms are seeking managerial profiles fitting the top manager, which may improve the odds of finding a similar or better managerial position outsider his current firm. Thus, a strong network may affect an executive director’s decision to leave when he feels threatened by an approaching dismissal as his network may enable him to leave his company at an earlier opportunity and prior to dismissal. An executive director’s network could also reflect his power or influence which could affect the board’s decision making and stall or ward off dismissal. As corporate underperformance may not only be the responsibility of executive directors but also of the non-executive directors on the board, we also study the impact of networks on the replacement of non-executives.

Second, we turn to the perspective of the firm and examine the board’s decision about hiring an internal versus an external candidate when a managerial or non-executive vacancy emerges. In general, an external director appointment involves more uncertainty due to asymmetric information, but the incumbent directors’ networks can mitigate this uncertainty. In the context of turnover and appointment, we focus on network centrality measures capturing information-gathering potential not only of directors but also of directors collectively (which comes down to studying the network at the company level).

Our study yields some interesting results: first, directors with better global information access (through indirect networks) are more likely to leave their current position for another firm. In contrast, executive and non-executive directors’ access to local information (proxied by direct connections) does not increase the probability of their departure. Nevertheless, a director with many direct connections stands a better chance of promotion in and retention by his firm as the direct connections may be a proxy for his influence or power in his firm. Second, when we investigate the factors affecting the probability of an external appointment, it turns out that outside candidates with strong indirect networks (with higher global information collection ability) are more likely to be invited to serve as executive directors. Specifically for the position of chairman, an external director with a strong direct connectedness has a higher probability of being invited to chair the board. So, director networks grant information access and hence enhance the directors’ labor market opportunities.

To sum up, the positive impact of indirect connections reflects the network’s information value and is in line with the “strength of the weak ties” theory (Grannovetter, 1973). This signifies that the connections to people that are close and local are likely to be stronger but then also convey much redundant information. On the contrary, connections to individuals on ‘brokerage’ positions, i.e., bridging to groups that are otherwise separated, are more efficient in terms of information acquisition and labor market performance improvement, even though such connections may only be indirect and hence weaker. We also find labor market performance can be improved by direct connections, particularly in terms of internal promotion and retention. This implies that direct connection may provide information and power in the local environment. Overall, both direct and indirect connections are valuable in the top managerial labor market.

The full paper is available for download here.

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