Abstract
The ‘effectiveness’ of boards has been the subject of numerous investigations by analysts and financial experts. They have not resulted in a consensus position. The studies have centred on major events such as corporate takeovers, restructurings, or replacements of the CEO. A substantial body of work has developed regarding the relationship of these events, and how they were addressed in the context of corporate governance. But this body of work has been too narrowly focused for any general findings on the governance performance relationship. The initial difficulty in generating conclusive empirical results stems from the failure to develop a proxy for board ‘independence’. Most studies have relied on some measure of board composition, such as the number of outside versus inside directors, to indicate ‘independence’.1 However, on their face, these surrogates are not associated with reform practices and shed little light on the conduct of an independent board.
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Footnotes
See Anil Shivdasani and David Yermack, ‘CEO Involvement in the Selection of New Board Members: An Empirical Analysis’, Journal of Finance, 54 (1999), 1,829–54.
See Anup Agrawal and Charles R. Knoeber, ‘Firm Performance and Mechanisms to Control Agency Problems between Managers and Shareholders’, Journal of Financial and Quantative Analysis, 31 (1996) 377–8.
Kenneth J. Rediker and Anju Seth, ‘Boards of Directors and Substitution Effects of Alternative Governance Mechanisms’, Strategic Management Journal, 16 (1995), 97–8.
See E. Fama, ‘Agency Problems and the Theory of the Firm’, Journal of Political Economics, 88 (1980), 288–307; E. Fama and Michael Jensen, ‘Separation of Ownership and Control’, Journal o f Law and Economics, 26 (1983), 301–25.
Benjamin E. Hermalin and Michael S. Weisbach, ‘Boards of Directors as Endogenously Chosen Institutions: A Survey of the Economic Literature’, unpublished manuscript available at http://www.nber.org/papers/w8161 (posted March 2001).
Jarrad Harford, ‘Takeover Bids and Target Directors’ Incentives: Retention, Experience and Settling-Up’, University o f Oregon Working Paper (2000).
See Tod Perry, ‘Incentive Compensation for Outside Directors and CEO Turnover’, working paper available at http://papers.ssm.com (July 2000).
See Sanjai Bhagat, Dennis C. Carey and Charles M. Elson, ‘Director Ownership, Corporate Performance, and Management Turnover’, Business Lawyer, 54 (1999), 885.
David Yermack, ‘Higher Market Valuation of Companies with a Small Board of Director’, Journal of Financial Economics, 40 (1996), 195, 202.
Scott W. Barnhart and Stuart Rosenstein, ‘Board Composition, Managerial Ownership, and Firm Performance: An Empirical Analysis’, Financial Review, 33 (1998), 11–12.
See James A. Brickley, Jeffery L. Coles and Gregg Jarrell, ‘Leadership Structure: Separating the CEO and Chairman of the Board’, Journal of Corporate Finance, 3 (1997), 189.
B. Ram Baliga, R. Charles Moyer and Ramesh S. Rao, ‘CEO Duality and Firm Performance: What’s All the Fuss?’, Strategic Management Journal, 17 (1996), 41.
L. Pi and S.G. Timme, ‘Corporate Control and Bank Efficiency’, Banking and Finance, 17 (1993), 515.
Paula L. Rechner and Dan R. Dalton, ‘CEO Duality and Organizational Performance: A Longitudinal Analysis’, Strategic Management Journal, 12 (1991), 155.
See, generally, Diane Del Guercio and Jennifer Hawkins, ‘The Motivation and Impact of Pension Fund Activism’, Journal of Financial Economics, 52 (1999), 293, 295, 297.
Roberta Romano, ‘Less is More: Making Institutional Investor Activism a Valuable Mechanism of Corporate Governance’, working paper available via http//:papers.ssrn.com (2000).
See Bernard S. Black, ‘Shareholder Activism and Corporate Governance in the United States’, in Peter Newman (ed.), The New Palgrave Dictionary of Economics and The Law (Palgrave, 1998).
Ibid.
Willard T. Carleton, James M. Nelson and Michael S. Weisbach, ‘The Influence of Institutions on Corporate Governance through Private Negotiations: Evidence from TIAA-CREF’, Journal of Finance, 53 (1998), 1,336.
Yilin Wu, ‘Honey, CalPERS Shrunk the Board’, working paper, University of Chicago (2000), available via http://papers.ssrn.com.
Studies cited in Romano’s paper pertinent to this question include: James M. Forjan, ‘The Wealth Effects of Shareholder-Sponsored Proposals’, Revised Financial Economics, 8 (1999), 61–72 (finding a negative wealth effect for shareholder-sponsored proposals at a large number of firms); Jonathan Karpoff, Paul Malatesta and Ralph Walkling, ‘Corporate Governance and Shareholder Initiatives: Empirical Evidence’, Journal of Financial Economics, 42 (1996), 365–95 (finding evidence that targeted firm operating performance improves following shareholder proxy proposals); Sunil Wahal, ‘Pension Fund Activism and Firm Performance’, Journal of Financial Quantative Analysis, 31 (1996), 1–23 (reporting no significant long-term stock price or accounting performance effect following pension fund shareholder proposals).
See James F. Cotter, Anil Shivdasani and Marc Zenner, ‘Do Independent Directors Enhance Target Shareholder Wealth During Tender Offers?’, Journal of Financial Economics, 43 (1997), 195.
See Chun I. Lee, Stuart Rosenstein, Nanda Rangan and Wallace N. Davidson III, ‘Board Composition and Shareholder Wealth: The Case of Management Buyouts’, Financial Management (Spring 1992), 58, 65–8.
See John W. Byrd and Kent A. Hickman, ‘Do Outside Directors Monitor Managers? Evidence from Tender Offer Bids’, Journal of Financial Economics (1992), 195, 203–4, 207.
See Paul Mallette and Karen Fowler, ‘Effects of Board Composition and Stock Ownership on the Adoption of “Poison Pills”’, Academy of Management Journal, 35 (1992), 1010, 1023; Sunil Wahal, Kenneth W. Wiles and Marc Zenner, ‘Who Opts Out of State Antitakover Protection? The Case of Pennsylvania’s SB 1310’, Financial Management, 24(3) (Autumn 1995), 22, 26–7; Chamu Sundaramurthy, Paula Rechner and Weiren Wang, ‘Governance Antecedents of Board Entrenchment: The Case of Classified Board Provisions’, Journal of Management, 22 (1996), 783.
See James A. Brickley, Jeffely L. Coles and Rory L. Terry, ‘Outside Directors and the Adoption of Poison Pills’, Journal of Financial Economics, 35 (1994), 371.
See Sanjai Bhagat and Bernard Black, ‘The Uncertain Relationship Between Board Composition and Firm Performance’, Business Lawyer, 54 (1999), 921–63.
See Sanjai Bhagat and Bernard Black, ‘Board Independence and Long Term Firm Performance’, working paper available via http://papers.ssrn.com (February 2000).
See Barry D. Baysinger and Henry N. Butler, ‘Corporate Governance and the Boards of Directors: Performance Effects of Changes in Board Composition’, Journal of Law, Economics and Organization, 1 (1985), 101, 116; Benjamin E. Hermalin and Michael S. Weisbach, ‘The Effects of Board Composition and Direct Incentives on Firm Performance’, Financial Management, 20 (Winter 1991), 111; Paul W. MacAvoy, Scott Cantor, Jim Dana and Sarah Peck, ‘ALI Proposals for Increased Control of the Corporation by the Board of Directors: An Economic Analysis’, in Statement of the Business Roundtable on the American Law Institute’s Proposed ‘Principles o f Corporate Governance and Structure: Restatement and Recommendations’ (1983), C-1, C-34; Hamid Mehran, ‘Executive Compensation Structure, Ownership and Firm Performance’, Journal of Financial Economics, 38 (1995), 163.
See, e.g., Barry D. Baysinger and Henry N. Butler, ‘Revolution Versus Evolution in Corporation Law: The ALI’s Project and the Independent Director’, George Washington Law Review, 52 (1984), 557, 562–6 (concluding that ‘as corporate board independence increases, corporate financial performance tends to increase’); James A. Brickley, J.L. Coles and R.L. Terry, ‘Outside Directors and the Adoption of Poison Pills’, Journal ofFinancial Economics, 35 (1994), 371, 371–2 (examining the stock price effects of poison pills to measure the extent to which more outside directors further promote shareholder interests); Victor Brudney, ‘The Independent Director — Heavenly City or Potemkin Village?’, Harvard Law Review, 95 (1982), 597, 601–2 (analysing the obstacles independent directors have encountered in policing managerial conflicts of interest and in monitoring the maximization of shareholder wealth); John W. Byrd and Kent A. Hickman, ‘Do Outside Directors Monitor Managers? Evidence from Tender Offer Bids’, Journal of Financial Economics, 32 (1992), 195, 196; Rajeswararao S. Chaganti, S. Sharma and V. Mahajan, ‘Corporate Board Size, Composition and Corporate Failures in Retailing Industry’, Journal o f Management Studies, 22 (1985), 400, 406–7 (Corporate performance measured in terms of return on investment, stock appreciation, or relative standing of the firm in its industry, may be associated more with technical expertise and managerial experience of inside directors than any other attribute of the boardroom’); Benjamin E. Hermalin and Michael S. Weisbach, ‘The Effects of Board Composition and Direct Incentives on Firm Performance’, Financial Management, 20 (1991), 101, 101–12 (concluding that ‘if such a relationship does exist, it is small with little economic significance’); Anil Shivdasani, ‘Board Composition, Ownership Structure, and Hostile Takeovers’, Journal of Accounting and Economics, 16 (1993), 167, 167–9 (limited impact of board and ownership structure on the likelihood of a hostile takeover).
See generally Michael S. Weisbach, ‘Outside Directors and CEO Turnover’, Journal of Financial Economics, 20 (1988), 431 (CEO turnover was more sensitive to firm performance in firms with a higher proportion of outside directors; boards with at least 60 per cent independent directors were more likely than other boards to fire a poorly performing CEO; but CEO termination rate for firms was only 1.3 per cent higher for those with 60 per cent independent boards than for those with 40 per cent or fewer independent directors; and, for firms with above average stock price performance, CEO turnover was lower for firms with 60 per cent independent boards).
See generally Byrd and Hickman, ‘Outside Directors’, 195–221 (tender offer bidders with majority-independent boards offer lower takeover premia and experience zero stock price change on average; bidders without such boards suffer stock price losses during takeovers of 1.8 per cent on average); James F. Cotter, A. Shivdasani and M. Zenner, ‘Do Independent Directors Enhance Target Shareholder Wealth During Tender Offers?’, Journal ofFinancial Economics, 43 (1997), 195, 204–5 (tender offer targets having majority-independent boards realized roughly 20 per cent higher stock price returns between 1989 and 1992 than targets without majority-independent boards; the initial tender offer premium, the bid premium revision, and the target shareholder gains over the tender offer period were higher; it appears that such independent boards were more likely to use resistance strategies to enhance shareholder wealth); cf. Shivdasani, ‘Board Composition’, 167–98 (companies with ‘high-quality’ directors, as defined by the number of boards on which they serve - apparently the more the better — are less likely to become takeover targets).
“The link between board characteristics and company performance is difficult, if not impossible, to isolate because of the multitude of other factors that impact corporate performance more directly. See, e.g., Robert Gertner and Steven N. Kaplan, The Value Maximizing Board (University of Chicago and National Bureau of Economic Research Working Paper 1996), 2 (indicating that ‘the link between board structure and performance occurs concurrently with numerous other factors’, thereby contributing to a ‘noise’ problem with performance regressions including board characteristics as independent variables). Moreover, boards are prone to restructure themselves in times of poor corporate performance, and therefore board structure is partially determined by past corporate performance. See Hermalin and Weisbach, ‘Effects of Board Composition’, 88, 102 (using panel data and instrumental variables to control for changes in board compositions due to past performance).
We note in passing that the search for econometric proof that good governance by an active and independent board matters to corporate performance by some has not seemed all that important. As the Nobel laureate in economics, Robert M. Solow, writes, ‘in economics, model-builders busywork is to refine their ideas to ask questions to which the available data cannot give the answer… We have the overeducated in pursuit of the unknowable.’ See Robert M. Solow, ‘How Did Economics Get That Way and What Way Did It Get?’, Journal of American Academy of Arts and Sciences (Winter 1997), 57. Solow also noted, ‘there is a tendency to undervalue keen observation and shrewd generalization…. There is a lot to be said in favor of staring at the piece of reality you are studying and asking, just what is going on here?’ (ibid., 56). But ‘does the absence of conclusive empirical proof… mean we should ignore the obvious linkage?’ See Ira M. Millstein, ‘The State of Corporate Governance’, Speech Before the National Association of Corporate Directors, 1 November 1993, in Robert A.G. Monks and Nell Minow, Corporate Governance (1995), 445, 451. The argument is as follows: ‘To me it is intuitively correct that to maximize the corporation’s wealth-producing capacity we must ensure that the accountability mechanism provided in the legal structure of the governance system works…’ Think about it: no one questions that the CEO’s performance matters a great deal to corporate performance. And the board is charged with hiring the best CEO it can find, helping the CEO set goals and priorities for the long-term viability of the corporation, monitoring his or her accomplishments against those goals and, if necessary, replacing him or her in a timely manner. How can board performance not matter to corporate performance?
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© 2003 Paul W. MacAvoy and Ira M. Millstein
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Millstein, I.M., MacAvoy, P.W. (2003). The Ambivalent Results of Extant Research on the Impact of Strong Governance on Corporate Performance. In: The Recurrent Crisis in Corporate Governance. Palgrave Macmillan, London. https://doi.org/10.1057/9781403946881_4
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