An Examination of Board Stability and the Long-Term Performance of Initial Public Offerings

Abstract

We study the long-term stockperformance of initial public offerings (IPOs). We examine howpast performance affects the board of directors 'stability and how changes in boards affect subsequent performance. We introduce a dynamic, scale invariant stability metric to measure such changes. Our results indicate that among IPO firms, those with poorer initial performance experience greater board instability and that greater board stability is associated with improvement in subsequent performance. These results indicate that board members leave poorly performing firms, rather than shareholders replacing ineffective boards. Retaining boards that experience initial good performance is associated with continued success. In this paper, we study IPO board stability and stock performance and explore two questions. Do IPO boards change in response to the firm's poor performance? How do changes in the board affect the firm's subsequent performance? When a firm goes public, both the ownership structure and the management structure of the firm change. Although prior to the initial public offering (IPO) the board of directors often owns a controlling stake in the firm, this stake may be drastically reduced after the completion of the IPO. Such changes lead to increased agency costs and the accompanying need for monitoring (see Jensen and Meckling, 1976; Leland and Pyle, 1977). Significant changes in the board of directors after the IPO may be necessary to ensure that the wealth of the new shareholders is maximized. We present evidence indicating that poor performance leads to board changes (greater instability), while better performance leads to board retention (greater stability). We also find that greater board stability is associated with improvement in subsequent performance among poorly performing firms. This result implies that when the boards of poorly performing firms are unstable, either shareholders are too hasty in making changes to the board or board members jump ship in an effort to protect their reputation capital. IPO boards provide a unique opportunity to examine board stability and the effectiveness of board changes. This opportunity arises not only because of the ownership and managerial changes that occur in young firms, but also because of the documented average severe longterm underperformance of initial public offerings. Although a clear explanation of the long run underperformance of IPOs has eluded financial researchers, examining changes in board stability may unearth new information about this underperformance phenomenon. This paper examines how IPO performance relates to changes in the board. We also examine the impact of changes in boards on subsequent performance. Subsequent improvement in performance following board changes may provide further evidence that the underperformance is firm specific, rather than