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1 November 2013 CFA Institute Journal Review

Does It Pay to Have Friends? Social Ties and Executive Appointments in Banking (Digest Summary)

  1. Martin A. Wildy, CFA

The tendency for people to form connections with others who are similar to themselves, or homophily, may play a role in the choices bank boards make when hiring executives. Common social factors, such as age, gender, education, and employment history, affect the likelihood that a bank will appoint an external versus internal candidate to executive positions.

What’s Inside?

Using a database of German banks over the 1993–2008 period, the authors seek to determine whether executive candidates are appointed based on social ties related to age, gender, and education, as well as connections arising from previous employment history with members of the executive board. The tendency to form connections based on similarities between people is called “homophily.” The authors also examine the extent to which homophily traits affect executive tenure and bank financial performance. The conclusion is that a number of common social traits are statistically significant in determining whether these boards favor internal or external candidates.

How Is This Research Useful to Practitioners?

Prior research in the area of executive appointments has shown that external executive appointments increase with the number of existing external directors and that external appointments are subsequently linked to positive abnormal stock returns. This study differs from others by focusing on how social ties affect the willingness of a board to consider external candidates.

The authors test age, gender, education, and employment background to determine how these factors affect the probability of a board hiring an external executive. Similarities with executive board members in age and employment history significantly increase the probability of an external appointee. The probability of a female external appointee is also higher when another woman already serves on the executive board. In contrast, having similar educational backgrounds reduces the chance of an external appointment. The authors attribute this result to increased rivalry between executives with similar educational backgrounds.

When examining other relationships, smaller age differences and ties among female executives are found to be associated with longer executive tenure. The authors also identify a weak positive relationship between common social factors and decreased return on equity, which they conclude is consistent with cronyism.

This research will be of interest to those following corporate governance issues, as well as individuals who serve on boards or are involved in hiring practices. The identified inclination toward homophily is important to be aware of when evaluating and selecting candidates.

How Did the Authors Conduct This Research?

The authors examine data for more than 10,900 executive appointments in the banking industry in Germany between 1993 and 2008. The datasets are obtained from the German central bank and the Deutsche Bundesbank. The data contain the identity and select biographical information of all bank executives and senior staff going back to 1970.

The authors develop tests that link each of the factors identified to the likelihood of selecting an external versus internal candidate. The factors are assessed for statistical significance, and a considerable amount of supporting data is provided that will be of particular interest to some readers.

Although their research is thorough, an issue the authors identify is that social data are only available for the executive board members even though it is the supervisory board that formally makes executive appointments. The authors assert that because executive boards wield considerable influence over the appointment process, this comparison is also valid.

Abstractor’s Viewpoint

The authors provide insight into the impact that common social factors have on banks’ appointment of executives. They help highlight potential biases that exist in this process. It is concerning that such factors as similar education background, gender, and age appear to influence this decision-making process. It would be interesting to know whether similar results apply to companies in other industries and countries and whether other social factors exert a similar influence. Additional insight into these biases may help increase the likelihood that the best candidates are selected based solely on merit.

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