Bridge over ocean
1 August 2013 CFA Institute Journal Review

Are Busy Boards Detrimental? (Digest Summary)

  1. Derek Bilney, CFA

Best practice guidelines for corporate governance discourage directors from holding positions on multiple corporate boards on the basis that directors are unable to devote sufficient time and resources to meet the monitoring requirements of the roles. But those so-called busy directors may be particularly suited to certain types of firms (such as IPO firms) because of their experience and contacts.

What’s Inside?

Previous studies highlighted that firms with boards composed of busy directors (directors that serve on several boards) underperform other firms on a number of metrics, which suggests that busy boards (those composed of more than half busy directors) are not effective at monitoring senior management. But the focus of earlier studies was predominantly on larger, more mature firms. The authors focus on the composition of boards of recently listed firms, with a particular emphasis on firms backed by venture capital. They find that for newly listed firms, busy directors actually add value with their specialized skills, experience, and networks.

How Is This Research Useful to Practitioners?

Owners of a firm at the time of an IPO have an incentive to ensure that the board is structured to maximize the value of the company. But the authors find that contrary to best practice corporate governance guidelines, the boards of newly listed firms have a significantly higher proportion of busy directors than the boards of more seasoned firms. They suggest that seasoned firms may require directors to focus more on monitoring, whereas newly listed firms may require directors with sector-specific and strategic skills because those types of firms typically grow at a faster rate and face different issues.

The authors also assess the characteristics of busy directors and suggest that they are busy because they are highly sought after for their connections and experience. By nature, many IPOs are in emerging industries in which the field of potential directorship candidates is relatively small. Busy directors are also more likely to have MBA degrees from either Stanford University or Harvard University and serve at a higher level on the board (for example, as chairman or on audit/remuneration committees). The authors note that a key difference between busy and non-busy directors is that busy directors are typically employed by large venture capital firms.

The authors track the structure of boards after the IPO and find that the number of busy directors decreases, which is consistent with the idea that as a firm matures, its requirements change.

Earlier research suggested a connection between busy boards and firm underperformance on a number of measures related to poor board monitoring. But those studies focused on older and larger firms. For newly listed stocks that are backed by venture capital and have busy boards, the authors produce contrary results. Interestingly, they are also unable to reproduce the link between busy directors and adverse performance for larger firms that are not backed by venture capital.

Practitioners, particularly those with an investment process that emphasizes the importance of corporate governance, may want to reassess the appropriateness of a one-size-fits-all approach to optimal board structure. Given the guidance provided by industry bodies and regulators over the past decade, this trend may be difficult to reverse.

How Did the Authors Conduct This Research?

The authors collect information on U.S. firms that went public from 1996 to 2008, with a particular focus on IPOs backed by venture capital, using information provided by Thomson ONE Banker. Detailed information on directors is gathered from prospectuses filed with the U.S. SEC. The authors define a busy director as a director who serves on three or more boards and a busy board as a board that is composed of 50% or more busy directors. Supplementary data are from a number of sources.

The authors divide their sample of IPOs backed by venture capital into two groups: those with directors associated with venture capital firms and those with directors not associated with venture capital firms. Each class of directors is further split into busy and non-busy, and differences in director quality are identified.

To assess the effect of board busyness on firm performance, the authors use the market-to-book ratio and the ratio of net income to sales measured one year after listing. Arguably, profitability-based measures should also have been included, although the lack of profitability for young firms may have distorted the results. Two-stage regressions are used at various points to remove any potential endogeneities in the data.

Abstractor’s Viewpoint

The authors provide a useful and convincing counterargument to the prevailing wisdom on the optimal structure of boards. It makes sense that a board needs directors with different skills and characteristics as it matures from an IPO firm to a more seasoned company. But it would seem unlikely that this evidence is sufficient to convince corporate regulators and corporate governance advisory firms to alter their requirements, given developments in board structure over the past decade. It is also possible that investors in very young or IPO companies may find that those companies benefit from having a “busy board” of the type studied.

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