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«Three essays on corporate boards R. Øystein Strøm A dissertation submitted to BI Norwegian School of Management for the degree of Dr.Oecon SERIES ...»

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In terms of policy implications, these findings provide no economic argument for mandating more independence or more diversity, such as requiring by law or recommending by code that a minimum fraction of directors be independent, employees, or of a particular gender. The fact that the relationship to performance for employee directors and gender diversity is statistically and economically significant may reflect that these mechanisms are not at their optimal level, whereas the insignificance for the independence mechanism reflects that it is. This means that if anything, the regulatory implication is the opposite of what has been argued in the public: Regulators should mandate more director owners and more networked directors, less employee directors, less gender diversity, and smaller boards. The independence mechanism needs no regulatory assistance.

2.5 Robustness

Whereas table 2.1 specifies alternative empirical proxies for several theoretical concepts, every regression model in section 2.4 uses just one set.

This section explores the robustness of our findings to alternative ways of empirically measuring the theoretical constructs of board independence, director network, gender mix, and board size.

The independence measure defined in expression (2.1), which we developed from the Hermalin and Weisbach (1998) logic, is based on the


tenure of non-CEO directors vs. the tenure of the CEO. As discussed, however, Carter and Lorsch (2004) argue that board independence is a matter of absolute rather than relative tenure, and that independence decreases rather than increases as tenure grows. We test this competing hypothesis by alternatively operationalizing independence as board tenure, CEO tenure, and chairman tenure. Under the Carter-Lorsch hypothesis, the expected relationship to performance is negative for board and chairman tenure and zero for CEO tenure.

The second alternative operationalization is for the director network variable. Unlike our more elaborate proxy, existing papers simply use the average number of outside directorships. We expect the estimated coefficient of this more coarse measure to have the same sign as our proxy, but to be less significant both economically and statistically.

Table 2.5 shows the results of re-estimating the fixed effects model (2.

2) under alternative proxies for independence (models (1)-(3)), director network (model (4)) and for one combination of the two (model (5)). Model (6) is the base–case model from table 2.3.

Table 2.5

Comparing the estimates of the base-case model (6) to those using alternative empirical proxies in models (1)-(5), the results are almost identical. According to the five statistically significant mechanisms in (6), the estimated sign and statistical significance for four of them (directors’ holdings, network, gender, and employee directors) are fully consistent across the models. The only difference is the loss of significance for board size when network is measured by the number of outside seats rather than information centrality. Notice also that this conventional definition of network reduces the economic significance of the network effect on performance by 45%. This suggests the economic content of our measure and the conventional measure is indeed different.

It may be argued that if we are concerned with the performance effect of board size or gender diversity, it does not matter whether the directors are elected by shareholders or employees. Due to potential multicollinearity and the desire to distinguish between stockholder-driven and employee-driven explanations, however, we have so far ignored employee directors in the gender and board size variables. To explore the effect of lifting this restriction, table 2.6 reestimates the base-case model from table 2.3, letting these two board characteristics reflect all the board’s directors rather than only those elected by stockholders.


Table 2.6

Two changes occur. Under alignment, the importance of directors’ holdings becomes slightly weaker. The p-value increases from 8.8% to 12.7%, but the economic significance remains the largest of all the mechanisms. The second change occurs for the decisiveness mechanisms, where employee directors and gender both become insignificant, and the significant size variable becomes slightly weaker. This is as expected, since the performance effect of what used to be in the employee directors variable only (model A) is now spread out over three variables (model B), watering out the separate effects of employee directors, gender, and size. Thus, including employee directors in the definition of size and gender prevents us from telling whether it is these board characteristics per se that interact with performance or whether we measure the effect of employee directors working indirectly and mixed up with stockholder elected directors through size and gender.

Overall, the robustness tests have shown that alternative ways of operationalizing independence, information network, gender diversity, and board size have no fundamental effect on the interaction between performance and board composition. This strengthens our belief in the base-case model in table 3 and the integrated mechanisms model in table 4.

2.6 Summary and conclusions

We find that board composition matters for value creation because it inuences the alignment of interest between principals and agents, the production of information for monitoring and advice, and the board’s effectiveness as a decision-maker. Owners on the board and directors with multiple directorships relate positively to performance, suggesting that directors with high ownership stakes have stronger monitoring and support incentives and that well-connected directors bring a valuable network into the boardroom. Increased diversity produced by larger board size, more gender mix, and more employee directors is always negatively associated with performance. This is consistent with the argument that heterogenous boards are less effective decision makers, and that employees successfully protect their interests in the boardroom at the expense of capital providers.

All these relationships are statistically significant, and the economic significance is stronger for insider ownership and networked directors than for size, gender, and employee directors. In contrast, we find no significant link between independence and performance, which supports the CHAPTER 2. ALIGNED, INFORMED, AND DECISIVE hypothesis that although more independence increases monitoring incentives, it reduces management’s willingness to share private information with the board. The net effect of these two opposing forces for the typical firm is zero, which means most firms in the sample have boards with optimal independence. That is, owners design boards with the proper mix of hands-off monitors and hands-on advisers.

Many board design mechanism in our sample firms are endogenously determined, both by performance and by each other. For instance, directors with wide networks produce high performance and gravitate towards well-performing firms, and networking declines when gender diversity increases. However, such endogeneity does not invalidate the estimated relationship between board mechanisms and performance as summarized above, since our methodology controls for endogeneity in single-equation estimation. Nevertheless, endogeneity makes it more difficult to separate cause from effect, which is a well-known, chronic problem in corporate governance research. Moreover, endogeneity makes regulation more challenging because restrictions which are supposed to limit the admissible range of one board mechanism, such as independence, influences the use of unregulated mechanisms, such as board size.

Several of our findings are politically controversial (such as the questionable role of diversity in the boardroom), run counter to key components of most countries’ current corporate governance regulation (such as the problematic role of independent directors), and point to directions for board research that differ from those implied by conventional wisdom (such as the importance of having stockholders rather than other stakeholders on the board). In particular, we find no economic argument for mandating independence or diversity, such as requiring by law or code that a minimum fraction of directors be independent, be employees or be of a given gender. If anything, regulatory implications are the opposite of what is argued in the public domain: Regulators should encourage more owners in the boardroom, more directors with multiple seats, fewer employee directors, less gender diversity, and smaller boards. Independence is already at its optimal level and needs no regulatory pressure of the type which is currently introduced worldwide. In fact, regulation aimed at preventing costly scandals in a small number of firms may end up destroying more value in the vast majority of firms.

It seems to us that board design has been shaped rather strongly by practitioners and regulators based on their personal experience, political agendas, and more recently by a concern with the prevention of corporate BIBLIOGRAPHY 49 governance scandals. This suggests a need for more academic research and less popular opinion on the characteristics of value-creating boards.

Our findings support such a claim, which is also in line with the observation by Becht et al. (2003) that board research is still in its infancy.

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