Bridge over ocean
20 December 2018 CFA Institute Journal Review

Zombie Board: Board Tenure and Firm Performance (Digest summary)

  1. Michal Szudejko

Examining the relationship among board of director tenure, firm value, and accounting performance, the authors find an inverted U-shaped correlation. Firm performance improves, as a result of increasing knowledge and experience, until the board achieves a certain age. After that point, self-entrenchment activities take precedence and economic values may decline.

How Is This Research Useful for Practitioners

The issue of director tenure is a hot topic in the literature on corporate governance. According to the authors, this discussion can be narrowed to the trade-off between knowledge accumulation and level of independence. In this way, they extend the scope of the debate on the optimal tenure for directors.

The authors divide their analysis into two parts. In the first part, they examine the relationship between board tenure and firm value as well as return on assets (ROA). In order to eliminate the impact of dispersion in individual directors’ tenures, the authors consider various measures of tenure diversity, such as the Herfindahl index. The results show that both an increase in board tenure up to a certain age (from 5 to 7 years) and a decrease from a certain point (from 13 years to 11 years) result in an increase in firm value and the ROA level. The maximum firm value is achieved when the average tenure of outside directors reaches approximately 10 years.

Next, the authors examine the relationship between board tenure and various corporate decisions. Their findings suggest that an increase in board tenure up to a certain point causes quality improvement in acquisition decisions, corporate disclosure, and CEO compensation practices. Beyond that point, an increase in the number of value-destroying activities can be observed.

The second part of the research addresses endogeneity concerns. The authors observe stock market reactions to announcements of sudden deaths of outside directors. These occurrences constitute unexpected exogenous shocks to board tenures. Such events drive board tenures away from the expected maximum levels and result in abnormal declines in stock exchange returns. This nonlinear phenomenon provides support for the causal interpretation of the relationship between board tenure and firm value.

The authors’ research provides empirical insight into the relationship between board characteristics and firm performance and shows how directors can be valued as one unit versus as individual directors. The study is part of the ongoing debate on whether there should be imposed limits on the tenure of board members.

How Did the Authors Conduct This Research?

The authors source firm data from the WRDS Investor Responsibility Research Center database, covering S&P Composite 1500 firms from the United States from 1998 to 2010. They use two data filters. The first is the availability of the starting year of the directorship for all board members for a given year. Missing information is sourced from the original proxy and 10-K filings, made available via Capital IQ and the EDGAR data retrieval system. The second is that financial data must be available from the Compustat database and CEO information, from the Execucomp database.

The sample comprises 2,222 firms and 12,846 firm-year observations. It is further reduced by the inclusion of information regarding M&A activity, corporate disclosure, and managerial compensation. The so-called death sample is a result of studying stock market reactions to sudden deaths of outside directors. The required data come from such various sources as Factiva, EDGAR, Capital IQ, and the S&P Register of Corporations.

Board tenure is defined as the average tenure (measured in years) of all outside directors. The average figure for this metric in the authors’ sample is 8.2, with a median of 7.7. The average CEO age is 55 years.

The data are analyzed using panel data regression, in which Tobin’s Q (the market value of a company divided by its assets’ replacement cost) and ROA are regressed against board tenure and other corporate governance, CEO, and firm attributes. In order to ensure robustness, the authors verify different specifications of the model. First, they check for the existence of fixed effects. Second, they verify the expanded model, with such additional firm-year controls as gender, ethnicity, age diversity, and director shareholding. Most of the additional variables prove to be statistically insignificant.

Abstractor’s Viewpoint

The issue of director tenure is, in my opinion, one of the key concerns for investors. The fundamental supposition is that with extended tenure, directors tend to drive their attention and activities toward entrenchment, thereby destroying the value or long-term performance of the company. Despite that fact, numeric insight into the matter is scarce. The existing literature focuses on board diversity. A statistical approach, as presented in the authors’ research, constitutes a valuable novelty. My general expectation is that the methodology presented needs to be proof tested on markets other than the US market.

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