Directors’ Career Concerns: Evidence from Proxy Contests and Board Interlocks

Shuran Zhang is Assistant Professor of Finance at Hong Kong Polytechnic University. This post is based on her recent paper. Related research from the Program on Corporate Governance includes Does Shareholder Proxy Access Improve Firm Value? Evidence from the Business Roundtable Challenge by Bo Becker, Daniel Bergstresser, and Guhan Subramanian (discussed on the Forum here).

Proxy contests often focus on directorial positions, where activist shareholders nominate an alternative slate of directors in an attempt to replace incumbent board members. Given shareholders’ limited ability to vote out directors in uncontested elections (e.g., Cai, Garner, and Walkling, 2009), proxy contests remain a powerful mechanism for director removal. In recent years, activists have become increasingly successful in accessing the US boardroom. According to FactSet, activists obtained board seats in 73% of proxy contests in 2014. At the firm level, prior research shows that proxy contests create shareholder value for target firms (e.g., Dodd and Warner, 1983; Mulherin and Poulsen, 1998; Fos, 2017). At the director level, however, proxy contests can impose significant career costs on individual directors. Existing evidence suggests that, following proxy contests, directors suffer losses of board seats not only at target firms but also at nontarget firms (Fos and Tsoutsoura, 2014). Despite the adverse effects of proxy contests on directors’ careers, little is known about whether or how directors respond to proxy contests. To mitigate potential career consequences, directors may change their behavior and initiate policy changes at other firms where they also hold board seats, that is, interlocked firms.

In my paper, Directors’ career concerns: Evidence from proxy contests and board interlocks, I examine the impact of proxy contests on directors’ behavior by analyzing how a proxy contest at one firm affects corporate policies at interlocked firms. On the one hand, proxy contests can threaten directors’ board seats at interlocked firms. Thus, directors sitting on multiple boards could be motivated to act preemptively and strengthen corporate governance at interlocked firms to minimize the possibility of losing other board seats. I label this hypothesis the “career concerns hypothesis.” On the other hand, proxy contests can distract directors and thus weaken corporate governance at interlocked firms. In particular, engaging with activists at target firms can distract directors and reduce the time and resources they allocate to interlocked firms. I label this hypothesis the “director distraction hypothesis.”

To test these hypotheses, I analyze firm policy changes after a company with whom the firm shares at least one board member is targeted by an activist in a proxy contest, using a sample of US firms in the Institutional Shareholder Services database from 1998 to 2014. The analysis is based on a difference-in-differences design that matches each interlocked firm to another company with the closest market capitalization in the same industry. I find that, in the year after proxy contests, interlocked firms reduce excess cash holdings, increase shareholder payouts, cut CEO compensation, and engage in less earnings management. The evidence is consistent with improved corporate governance at interlocked firms.

The analysis of heterogeneity in the policy changes across interlocked firms yields a number of interesting results. First, I find greater reductions in CEO compensation and earnings management when the interlocking director sits on the compensation and audit committees, respectively. These results are consistent with the view that interlocking directors initiate the policy changes. Second, I find that the policy changes are more prominent when both the interlocked and target firms have a unitary board and when the interlocking director is up for election at both firms. These results indicate that directors have stronger motivation to act preemptively when they face higher risk of removal. Third, using age and tenure as proxies for directors’ implicit career incentives, I find that younger and shorter-tenured interlocking directors, who are earlier in their careers and are thus more concerned about the market’s perception of their ability, induce greater policy changes.

Supporting the career concerns hypothesis, I also find that directors are less likely to lose board seats at interlocked firms that make greater overall policy changes and these interlocked firms have a lower likelihood of being targeted by activists in the future. Finally, I find that stock prices of interlocked firms react favorably to the announcements of proxy contests, suggesting that shareholders anticipate value-enhancing policy changes.

This paper contributes to the literature in several ways. First, this paper provides novel evidence on the role of career concerns in aligning directors’ incentives with those of shareholders. The results are consistent with directors facilitating policy changes that shareholders desire when facing increased career concerns. Second, the results in this paper shed new light on the long-standing debate on the efficacy of shareholders’ ability to remove directors. The findings suggest that the risk of removal by shareholders motivates directors to improve governance. Third, this paper adds to the ongoing debate on the influence of shareholder activism. I find that, after board members experience shareholder activism at other firms, companies increase payouts but do not reduce long-term investment, which is inconsistent with shareholder-driven short-termism. Fourth, this paper expands a burgeoning literature that establishes that the impact of shareholder activism can reach beyond target firms. While existing studies focus on industry spillovers, this paper examines a completely different network through which the disciplinary effects of shareholder activism can spill over to nontarget firms—the board interlocking network. Fifth, this paper complements previous work on board interlocks between firms by showing that a proxy contest at one firm induces policy changes at interlocked firms. The results in this paper illustrate a specific channel through which board interlocks could create shareholder value.

The full paper can be accessed here.

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