Director Networks: Good for the Director, Good for Shareholders


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A director’s social and professional network contributes many positive benefits that increase shareholder value. Why isn’t more attention paid to the relation between personal networks and governance quality?

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Director Networks: Good for the Director, Good for Shareholders

  1. 1. Topics, Issues, and Controversies in Corporate Governance and Leadership S T A N F O R D C L O S E R L O O K S E R I E S stanford closer look series 1 Director Networks: Good for the Director, Good for Shareholders Board Networks A director’s social and professional network contrib- utes to his or her qualifications as a board member. Networks are important in that they create links be- tween individuals and organizations through which support, influence, and information are shared. For this reason, executives with a broad network tend to be highly valued as director nominees.1 Google is an example of a company with a well- connected board. At the time of the company’s initial public offering in 2004, it shared director affiliations with many successful institutions in Sili- con Valley, including Apple, Cisco, eBay, Intel, and Yahoo! It was also connected to firms outside of the area, including Amazon and Wal-Mart. It is not in- conceivable that these connections contributed to the company’s success as both a start-up and a pub- licly traded corporation (see Exhibit 1). In recent years, however, much attention has been paid to the negative aspects of inter-board con- nections. This is because network connections have the potential to cause negative outcomes that im- pair economic value and reduce governance quality. For example, director networks may lead to the fol- lowing: • The spread of bad practices. There is consider- able evidence (and informed speculation) that bad practices such as stock option backdat- ing are transferred across companies through boardroom connections.2 Directors observing a practice at one firm may bring it to others with which they are affiliated. • The spread of bad information. Incorrect in- formation may also be shared across companies through board networks. False rumors—such as By David F. Larcker and Brian Tayan August 5, 2010 those of a new product launch, marketing strat- egy, price increase, or pending acquisition—can cause companies to make ill-informed decisions, which destroy economic value. • A reduction of director effort and attention. A well-connected director will sit on more than one board, each requiring a certain amount of time and attention. Academic research has shown that directors that sit on multiple boards (“busy di- rectors”) tend to provide worse oversight. Busy boards are correlated with higher executive com- pensation, reduced likelihood of terminating a CEO for poor performance, and a higher likeli- hood of earnings manipulation.3 • Collusion. Board networks may be a conduit through which firms engage in collusive activity, such as price fixing, illegal division of sales terri- tories, and other anti-competitive behaviors. For these reasons, the Clayton Antitrust Act of 1914 prohibits shared directorships among companies that are in direct competition. At the same, not enough attention has been paid to the positive effects of board networks. Board interconnections allow for the flow of valuable in- formation that can enhance decision making and improve economic performance. Examples include: • Sharing of market information. Directors with deep networks possess considerable knowledge of industry trends, market condition, and regu- latory changes. Directors that represent impor- tant affiliates—such as customers, suppliers, or providers of capital—can facilitate the flow of information along the supply chain, thereby im- proving efficiency. • Sharing of management practices. Directors can
  2. 2. stanford closer look series 2 Director Networks: Good for the Director, Good for Shareholders deliver information about management practices and organizational improvements based on their experience at other firms. This lessens the learn- ing curve and reduces adoption risk at subse- quent firms. • Negotiating information. Director connections may allow two firms to negotiate better contracts by improving trust, sharing information, and re- ducing information asymmetry. • Professional contacts. Director networks may serve as a source of important business relation- ships, including new clients, suppliers, sources of capital, political connections, regulators, and director and executive referrals. These positive effects have been demonstrated through the academic literature. For example, Larcker, So, and Wang (2010) find that companies with a well-connected board have greater future op- erating performance and higher future stock price returns than companies whose boards are less con- nected. These effects are most pronounced among companies that are newly formed, have high growth potential, or are in need of a turnaround. The au- thors conclude that “boardroom networks have an important and positive impact on the economic performance of a firm.”4 Why This Matters 1. Governance experts spend considerable time talking about the negative effects of board inter- connections, including reduced independence, a culture of back scratching, and an “old boy network.” At the same time, it is important to understand that these connections can deliver tangible, positive value that benefits the organi- zation and its stakeholders. 2. Rather than evaluate boards based on indepen- dence standards and other superficial structural attributes, more attention should be paid to how board members’ professional backgrounds and network of connections contribute to gov- ernance quality and shareholder value creation. Why is it so difficult for commercial governance ratings firms to incorporate this information into their analyses?  1 For more on this topic, see also: David F. Larcker, Eric C. So, and Charles C. Y. Wang, “Boardroom Centrality and Stock Returns,” (July 24, 2010). Rock Center for Corporate Governance at Stanford University Working Paper No. 84. Available at SSRN: http://ssrn. com/abstract=1651407. 2 John M. Bizjak, Michael L. Lemmon, and Ryan J. Whitby, “Op- tion Backdating and Board Interlocks.” (February 1, 2007). Review of Financial Studies, Forthcoming. Available at SSRN: http://ssrn. com/abstract=946787; and Christopher S. Armstrong and David F. Larcker, “Discussion of ‘The Impact of the Options Backdating Scandal on Shareholders’ and ‘Taxes and the backdating of stock op- tion exercise date,” Journal of Accounting and Economics, 47, p.50-58. 3 Eliezer M. Fich and Anil Shivdasani, “Are Busy Boards Effective Monitors?” Journal of Finance, April 2006, Vol. 61, Issue 2, p. 689- 724. 4 Larcker, So, and Wang (2010), loc. cit. David Larcker is the Morgan Stanley Director of the Center for Leadership Development and Research at the Stanford Graduate School of Business and senior faculty member at the Rock Center for Corporate Governance at Stanford University. Brian Tayan is a researcher with Stanford’s Cen- ter for Leadership Development and Research. They are coauthors of the books A Real Look at Real World Cor- porate Governance and Corporate Governance Matters. The authors would like to thank Michelle E. Gutman for research assistance in the preparation of these materials. The Stanford Closer Look Series is a collection of short case studies that explore topics, issues, and controversies in cor- porate governance and leadership. The Closer Look Series is published by the Center for Leadership Development and Research at the Stanford Graduate School of Business and the Rock Center for Corporate Governance at Stan- ford University. For more information, visit: Copyright © 2012 by the Board of Trustees of the Leland Stanford Junior University. All rights reserved.
  3. 3. stanford closer look series 3 Director Networks: Good for the Director, Good for Shareholders Google Apple Yahoo! eBay Pixar Wal-Mart Cisco Arthur Levinson CEO, Genentech John Doerr Kleiner Perkins (VC) Amazon John Hennessey President, Stanford U. Paul Otellini CEO, Intel Intel Fred D. Anderson Elevation Partners (PE) Steve Jobs CEO, Apple Jerry Yang Founder, Yahoo! Michelle Burns CFO, Mirant Intuit William Campbell Chairman, Intuit Dennis Powell CFO, Cisco Exhibit 1 — Network Connections: Google Directors (2005) A subset of Google’s board network in 2005, the year after its successful IPO.