The Influence of Directors from Related Industries in Shaping Firm Policies

Abstract

Does the specific background and expertise of outside directors influence corporate policies? While the literature recognizes that directors contribute to firm value through their monitoring and advisory functions, the precise manner and extent to which directors’ expertise affects the firm’s operational and financial decisions is not well understood. We analyze this issue by identifying a group of directors that are likely to have considerable knowledge about the firm’s industry: directors from related upstream (supplier) or downstream (customer) industries (DRIs). We then investigate the impact of DRIs on specific corporate policies. We find that firms with DRIs benefit from: (1) shorter cash-conversion cycles, (2) lower inventory, (3) lower accounts receivable and, (4) higher accounts payable. We also find that firms with DRIs are less financially constrained as indicated by their lower cash-to-cash flow sensitivities. In addition, the investment to cash flow sensitivity is also lower with DRIs, thereby suggesting that they reduce investment distortions within firms. Further, investment responds less to stock prices (measured by Tobin’s Q) in firms with DRIs when the stock prices are not very informative – suggesting that DRIs act as alternative conduits of information. In a similar vein, we find that firms with DRIs utilize their production factors more efficiently (as measured by labor and total factor productivity), thus signifying that the industry expertise of DRIs helps the firm better anticipate industry conditions and trends.