Busy Directors and Firm Performance: Evidence from Mergers

Roie Hauser is Assistant Professor of Finance at Temple University Fox School of Business. This post is based on his recent article, forthcoming in the Journal of Financial Economics.

In my article, Busy Directors and Firm Performance: Evidence from Mergers, forthcoming in the Journal of Financial Economics, I study directors’ concurrent service on boards of multiple companies. More than 20% of directors in S&P1500 companies hold multiple board seats and nearly 85% of S&P1500 firms share at least one director with other S&P1500 firms. While critics debate the efficiency of this practice, numerous studies report mixed results on its merits. The main hurdle in estimating the causal effect of concurrent directorship is the endogeneity of board composition, and specifically, that this effect is entangled with directors’ skills. Highly skilled directors are likely to hold multiple board seats; they are pursued by many firms precisely for their expertise (Fama and Jensen, 1983, Kaplan and Reishus, 1990).

I overcome this hurdle with a setting that limits the investigation to variation in board seats induced by mergers. In this setting, mergers provide a natural experiment to study the performance of firms that share a director with an acquired firm (and are not involved in the merger otherwise). When two firms merge into one, the vast majority of directorships in the acquired firm are terminated (Harford, 2003). The “lost” board seat of those directors is a shock to other firms which continue to employ them. Econometrically, the advantage of this approach is that it allows for examining changes in firm outcomes as board appointments vary, while absorbing firm and director characteristics. These mergers generate variation in directors’ appointments over time rather than variation due to changes in board personnel. This approach is fundamentally different from studies using within-firm variation in board seats, since most of the within-firm variation in board seats reflects changes in personnel, which bear both the effects of appointments and skill.

The main finding is that performance improves with reduced board seats. Merger-induced reductions in directors’ concurrent board seats are associated with increases in earnings and in market-to-book ratios of the companies that continue to employ the shocked directors, compared to firms without shocked directors, operating in the same industry at the same time. For instance, a reduction of one seat on an S&P1500 board is associated with a temporal increase of about 0.3% in return on assets. For the median S&P1500 company, the increase amounts to nearly $6M in operating income. This analysis attributes these differences to the effect of directors’ concurrent appointments.

Two inferences are warranted. One is that directors matter and effective boards can indeed add value; the second is that concurrent board seats impose a cost on firm performance when the composition of the board is fixed. I argue that the systematic link between firms’ performance and changes in their directors’ external duties is evidence of directors’ causal effect. Since the shocks originate in firms that are related through a shared director, it follows that this director is channeling the response.

Next, I investigate underlying explanations for the observed effects of merger-induced reductions in board seats. In particular, I evaluate the empirical plausibility of two main explanations: an effect of directors’ workload on their effectiveness, and a direct effect of the merger transaction that led to termination of a board. The workload effect posits that relieving a director from the work duties on one board frees some time. That director can allocate the extra time among all her or his other remaining efforts, and in turn add value to those firms. An alternative explanation is a merger transaction effect, which posits that the findings are a result of the merger transaction itself. For example, directors could in principle become more effective immediately after a merger if they gain experience during the merger process, or if their incentives change due to a disciplining effect of takeovers.

I examine the workload effect vis-a-vis a merger transaction effect by testing their implications with regards to geographical distances between directorships. If reduced workload drives the improvements in performance, its effect should be pronounced for boards that are located far apart. This is because directors who are distant from company headquarters not only become busier due to time spent traveling, but also may face additional obstacles to monitor given the distance (Alam et al., 2014).

Consistent with an effect of directors’ workload, I find that performance gains are particularly stark where the terminated directorships are far. Overall, I find little evidence to support alternative explanations such as a merger transaction effect, while the collective evidence supports the implications of a workload effect. In particular, any alternative explanation would have to account for both the trends of improved performance and its interaction with distance. For example, the merger transaction effect falls short of explaining these findings: neither gaining experience nor disciplining effects provide a good hypothesis for why mergers would influence remote directors more than nearer directors. In addition, a falsification test exploiting withdrawn bids to capture potential alternative effects of merger bids (net of the effect of workload) does not produce evidence to speak for a merger transaction effect. These analyses point to director workload as the most probable reason that changes in board seats affect performance: directors do more to benefit the company when they work less elsewhere.

I find additional evidence consistent with a workload effect by examining changes in directors’ committee participation and attendance. The data show that directors are substantially more likely to join board committees in the year immediately following a merger-induced reduction in board seats. Reduction of one board seat is associated with about 4% higher likelihood to join board committees and about 3% higher likelihood to become chair of a committee in each board the shocked directors remain on, compared to a control group of directors that are not shocked. This analysis corroborates the previous findings since directors’ ability and willingness to take on time-intensive committees assignments can make them more influential.

Critics question whether directors are overcommitted and too busy to fulfill their monitoring and advising duties optimally. The concerns escalate when directors serve on multiple boards and their workloads compound. If directors were already devoting the maximum required effort to all their boards, a negative shock to workload should not have an effect. An implication of my analysis is that this is not always the case. A response to negative shocks to workload suggests that directors are optimizing their efforts given a binding time constraint. The findings do not imply, however, that a policy for intervening with firms’ hiring decisions is justified. This article is not meant to compare the costs to potential benefits of multifold utilization of highly qualified directors (such as networks, experience, expertise) or to evaluate the combined effect on total welfare. Rather, this article isolates the direct effect of concurrent board seats where board composition is fixed, and by that, reveals a real impact of boards.

The complete article is available for download here.

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