Lower Board Independence Research Articles

Pension funding gaps: do mandated external governance mechanisms matter?

PurposeThis study aims to examine whether and how the experience of specialized external governance mechanisms mandated by the Employee Retirement Income Security Act of 1974 – the actuary and auditor – affect pension plan funding.Design/methodology/approachThis study uses data from annual pension plan regulatory reports (Form 5500), Form 10-K filings, Form DEF 14A filings (company proxy statements) and publicly available data sources. The hand-collected data include information related to the pension plan’s actuary and auditor and various pension plan data disclosed in the company’s financial statement footnotes.FindingsThe author finds that more experienced actuaries and auditors are associated with better funded pension plans, especially when the company has higher financial risk or lower board independence. Additional analyses indicate that companies with more experienced actuaries and pension plan auditors are more likely to make higher annual pension plan contributions and hold fewer Level 3 fair value assets.Originality/valueThe dearth of pension plan governance research generally focuses on whether and how internal governance mechanisms affect pension plan funding. To the best of the author’s knowledge, this is the first empirical study of the relationship between external pension plan governance mechanisms and pension plan funding.

Corporate governance mechanisms and firm performance in Saudi Arabia before and during the COVID-19 outbreak

This study examines the impact of corporate governance mechanisms on the performance of listed firms in Saudi Arabia before and during the coronavirus disease (COVID-19) pandemic. The study applied univariate, bivariate, and multivariate analyses to data collected from 258 annual reports from 2019 to 2020. The results show that during the COVID-19 pandemic, firm market performance (Tobin’s Q ratio) has decreased with larger board size, more board meetings, while it has increased with board experience, board education, and board gender (number of women on the board). Moreover, during the COVID-19 pandemic, board gender was found to have a significant positive impact on the firm’s operational performance (return on assets), implying that gender diversity on boards plays a crucial role in times of crisis. The findings have significant implications for Saudi Arabian firms, managers, investors, and policymakers. Furthermore, the latest corporate governance regulations in Saudi Arabia are almost certain to have a significant impact on firm performance, particularly during times of crisis. In addition, corporate governance regulations should consider the importance of small board size, lower board independence, board member experience and education, and board gender diversity to improve corporate performance, especially in times of crisis. Governments and regulators should collaborate to reduce the financial and economic impact of the COVID-19 pandemic. Comprehensive policies are needed to address the negative consequences of current and future crises.

The Role of Multiple Large Shareholders in Dividend Payouts: Evidence from India

This study examines the impact of multiple large shareholders (MLS) on a firm’s dividend payouts in a low-investor protection regime, India, where minority shareholders’ expropriation concerns are severe and firms have an incentive to build a capital market reputation. Therefore, we purport for the prevalence of the substitution hypothesis, whereby MLS cooperate in paying larger dividends to assuage expropriation concerns for reputation-building. The empirical analysis using non-financial firms with MLS listed on NIFTY 500 from 2009 to 2019 yields that both the controlling owner and MLS positively influence dividend payout intensity. Additional analyses also demonstrate that the positive effect of MLS is prominent in growing firms that undertake equity issuances and firms with lower board independence. We also find that firms make relatively lower payouts when an institutional investor is the second largest shareholder. Further, it is shown that MLS engage in greater dividend smoothing. Lastly, it is observed that dividends are more valuable for firms with higher MLS ownership. Altogether, these findings support the substitution hypothesis.

Corporate governance and labor investment efficiency: International evidence from board reforms

AbstractResearch Question/IssueThis study investigates whether and how board reforms affect labor investment efficiency using a difference‐in‐differences analysis of board reforms in 41 countries worldwide as an exogenous shock.Research Findings/InsightsBoard reforms are positively associated with labor investment efficiency because they benefit firms in reducing over‐hiring, under‐firing, under‐hiring, and over‐firing. Further, we show that the positive effect is more pronounced among firms with lower board independence before the reforms, firms with high institutional foreign ownership, firms with higher corporate social responsibility (CSR), and labor‐intensive firms. While countries with rule‐based reforms experience a greater reduction in abnormal net hiring post‐reform, the effects of reforms are similar across civil and common law countries. Further analyses reveal that in countries with higher employment protection legislation, the beneficial relationship between board reforms and labor investment efficiency is weaker.Theoretical/Academic ImplicationsOur study suggests that one of the mechanisms linking board reforms and labor investment efficiency is a reduction in frictions, such as moral hazard and adverse selection, which hamper efficient labor investment. To the best of our knowledge, this is the first international study that explores globally the relationship between board reforms and firm labor policies, in particular, labor investment efficiency.Practitioner/Policy ImplicationsGiven the importance of identifying and confirming the role of corporate governance in human capital investment efficiency, our empirical investigation provides useful insights and policy implications for managers in building efficient labor policies.

Board Capital Diversity as a Governance Mechanism: Evidence From Latin America

This paper analyzes the effects of board capital as a corporate governance mechanism on firm performance in the context of a weak legal regime for investor protection. The study focuses on Latin America as a representative emerging market that includes a dataset of 442 firms in six countries (Argentina, Brazil, Chile, Colombia, Mexico, and Peru) from 2001 to 2012. We measure board capital as a composite index of directors’ educational attainment and professional experience. We find a positive relationship with differential effects between board capital and firm performance within weak firm internal governance schemes such as firms with low board independence, dual roles as firm CEOs and COBs, and low blockholder contestability. With respect to country-level governance standards, we find that improvements in the country’s regulatory quality, the rule of law, and corruption control reduce the need for firm board capital as an internal governance mechanism.

How does internal governance affect banks\u2019 financial stability? Empirical evidence from Egypt

This paper investigates whether internal governance mechanisms were associated with the financial stability of Egyptian banks over the period 2010–2019. To this end, a GMM regression analysis was employed using 252 firm-year observations. The results, in general, indicate that the level of banks’ financial stability is positively associated with board size, board meetings, and board gender. In contrast, the results show that board education and the ownership of shares by directors are negatively associated with banks’ financial stability. More interestingly, our results demonstrate that higher financial stability is significantly associated with lower board independence, the presence of CEO duality, and fewer audit committee meetings. These striking results can be attributed to the argument that the presence of independent directors on the board may reduce the CEO’s willingness to share information with board members, causing a high level of uncertainty in the decision-making process, which ultimately leads to a reduction in the financial stability of their bank.

Which Firms Require More Governance? Evidence from Mutual Funds' Revealed Preferences

This paper estimates mutual funds’ preferences for governance structures, using data on proxy vote records. I elicit funds’ revealed preferences by studying the differences in their votes on the same issue across their portfolio firms’ shareholder proposals, and develop funds’ preference rankings by implementing the Metropolis-Hastings Markov chain Monte Carlo algorithm. Funds prefer firms with low board independence, high insider ownership, and high abnormal compensation to adopt certain governance provisions that increase shareholder rights. Contrary to the view that the net benefits of takeover defenses are higher for young and small firms, funds are not enthusiastic about large and mature firms increasing shareholder rights. Large and mature firms are disproportionately targeted by shareholder proposals, suggesting the possibility that investors vote down worthless proposals submitted to such firms. I find a mixed relation between fund preferences and firm performance. Active and passive funds have similar preferences. Fund preferences are moderately correlated with overall vote support on relevant shareholder proposals.

Short Selling and Firm Investment Efficiency

This paper investigates the informativeness of short sales on detecting a firm’s investment inefficiency. We document that short sellers adjust their short positions before the financial statement announcements to utilize their information advantage on firms’ investment inefficiency. The relationship between a firm’s short sale position and its future investment inefficiency is both statistically and economically significant, and robust to a broad set of control variables. Subsample analysis shows that the informativeness of short sales positions on future investment inefficiency concentrates on firms with low board independence and firms with low CEO incentive pay.

Corporate Governance and Equity Prices: The Effect of Board of Directors and Audit Committee Independence

This paper investigates the effect of board and audit committee independence on firm market performance. Using a sample of French listed firms, we find a negative and significant relation between board independence and equity returns. This suggests that appointing more independent directors fails in enhancing firm stock returns. Furthermore, we show that firms with independent audit committees exhibit higher equity returns. We analyze three portfolios sorted by the percentage of independent directors on boards and audit committees using Carhart’s model and find that the portfolio of firms with low board independence and high audit committee independence exhibits the highest abnormal returns. JEL Classification: G34, G11

CEO Duality, Agency Costs, and Internal Capital Allocation Efficiency

AbstractThis study examines the impact of CEO duality on firms’ internal capital allocation efficiency. We observe that when the CEO is also chair of the board, diversified firms make inefficient investments, as they allocate more capital to business segments with relatively low growth opportunities over segments with high growth opportunities. The adverse impact of CEO duality on investment efficiency prevails only among firms that face high agency problems, as captured by high free cash flows, staggered board structure and low board independence. Depending on the severity of the agency problem, CEO duality is associated with a decrease in industry‐adjusted investment in high‐growth segments of 1% to 2.1% over the following year, relative to that in low‐growth segments. However, CEOs’ equity‐based compensation curbs the negative effect of CEO duality on internal capital allocation efficiency. Overall, the findings of this study offer strong support for the agency theory and postulate the internal capital allocation policy as an important channel through which CEO duality lowers firm value in diversified firms.

The Externality in the CEO Market and Regulating Board Independence

This paper discusses shareholder value and regulation on board independence. Shareholder value increases with a firm’s and, more importantly, other firms’ board independence. Shareholders set inefficiently low board independence because they fail to internalize the positive externality of higher board independence on other firms or they use low board independence to compete for CEO talent. This suggests that shareholder activism cannot substitute regulation. However, mandating minimum board independence can only remove the inefficiency caused by talent competition but not externality.

Corruption, Corporate Social Responsibility and Financial Constraints: International Firm‐level Evidence

This study examines the relationship between firm‐level factors including corporate social responsibility (CSR) performance and financial constraints, and the firm‐level risk of corruption. Facing a measurement challenge referring to firm‐level risk of corruption, we define a corruption score based on corporate disclosures of corrupt activities. We show that, first, CSR performance is negatively related to the risk of corporate corruption. Second, a firm's vulnerability to financial constraints is positively related to the risk of corporate corruption. Third, the effects are particularly strong for firms with low board independence. Finally, we contribute to prior literature by developing the first firm‐level corruption score that is not only robust to prevalent corruption indices but is also applicable to any dataset and can be used for future research on firm‐level corruption. Moreover, the study provides new empirical evidence on firm‐level determinants that relate to corporate corruption risk.

Directors' and officers' liability insurance and stock price crash risk

We investigate the impact of directors' and officers' insurance (D&O insurance) on stock price crash risk. We find that D&O insurance in China is negatively associated with stock price crash risk. This association is robust to a series of robustness checks including the use of alternative sample, Heckman two-step sample selection model, propensity score matching procedure, fixed effects model, the inclusion of some possibly omitted variables, and bootstrap method. Further analyses show that the impact of D&O insurance on crash risk is more pronounced in firms with lower board independence, non-Big 4 auditors, lower institutional shareholdings, and weaker investor protection; and the negative relationship between D&O insurance and crash risk is not driven by the eyeball effect. Moreover, we find that D&O insurance purchase is associated with less financial restatements and more disclosure of corporate social responsibility reports. Our findings provide support to the notion that D&O insurance appears to improve corporate governance.

The Strategic use of Language in Corrupt Firmss Financial Disclosures

This paper explores the role of language (tone and readability) in financial disclosures in detecting a firm’s likelihood of violating the FCPA. Matching FCPA violators with a control sample of non-violators, we examine whether the tone and readability of management’s 10-K filings can be linked to the likelihood of getting involved in an FCPA violation. We find that the management of FCPA violators uses more negative, uncertain, litigious, and complex language when disclosing financials compared to non-violators. Furthermore, we find that managers make strategic use of language after FCPA prosecution. Although they face additional litigation risk from FCPA prosecution, they lower their negative, uncertain, and litigious tone in 10-K filings. This effect is particularly strong for firms with low readability in SEC filings and low board independence.

On the determinants of director additions and removals

This article studies director additions and removals for S&P 500 firms during the period 2000 to 2003. It finds that firms with smaller board size than estimated efficient levels add more and remove fewer directors than firms with larger board size. It also finds that firms with lower board independence than estimated efficient levels add more and remove fewer independent directors, and add fewer and remove more nonindependent directors than firms with higher board independence. These findings suggest that firms add and remove directors to adjust board structure in a manner consistent with economic efficiency.

How Much of the Diversification Discount Can be Explained by Poor Corporate Governance?

We investigate whether the diversification discount is simply a proxy for poor corporate governance. We find that the negative value impact of diversification is amplified by adverse governance variables such as low CEO ownership, low board independence, and board classification, and that approximately 25% to 30% of the diversification discount can be attributed to suboptimal governance choices by conglomerate firms. Our methodology includes a dynamic panel GMM estimator that accounts for the endogeneity of the diversification decision and corporate governance, plus an event study analysis of diversifying mergers. Even after controlling for governance, the diversification discount remains negative and significant.

Convergence in the Ownership and Governance of East Asian Firms?

Corporate governance policies over the past decade have required all firms to follow the same guidelines. As a result, we examine whether the ownership and governance choices of East Asian family firms have converged to those of non-family firms. We find that family firms continue to maintain higher board representation and lower board independence than most other firms. We also examine differences among family firms (founded versus acquired and first versus second generation). We find that acquired family firms are owned differently but governed the same as founded family firms and that second generation family firms have a higher control wedge, higher board representation and lower board independence than first generation family firms. The results show that ownership and governance choices continue to differ between firms depending on the identity and generation of the controlling owner. From an agency cost perspective, the firms requiring more emphasis on corporate governance are second-generation family firms and government-controlled firms.For policymakers, our analysis indicates that voluntary corporate governance codes have not been successful in encouraging the convergence of ownership and governance practices across firms. Some policy suggestions for the future include setting mandatory lower bounds on board independence and mandatory upper limits on board representation (equal to ownership rights). This will help to minimize the variation across firms around the specified target. Our analysis also shows that it would be possible to customize recommendations across a small number of identifiable sub-groups of firms, e.g. family firms, individual-controlled firms, government-controlled firms and widely-held firms, rather than using one set of recommendations for all firms.

Corporate Governance Mechanisms for Monitoring or Empowering CEOS? A Study of Chinese Listed Firms

This study examines the impact of governance mechanisms in monitoring or empowering top executives on firm performance. We distinguish between two competing theories, namely agency theory and stewardship theory, which hold conflicting assumptions about CEOs behaviour and hence offer different recommendations concerning corporate governance structure. We conduct an empirical study based on 837 publicly listed companies in China over the period of 2005-2007, the findings of this study provide strong support for stewardship theory. The results suggest that governance mechanisms that can empower CEOs work better in the Chinese context, specifically, a longer CEO tenure and lower board independence can have positive effects on firm performance.

Why do family firms congregate in certain industries?

We propose that family firm involvement and performance across industries is not random and is related to specific industry conditions. Using the population of listed companies on the Taiwan Stock Exchange over the period 1997-2007 we find that family firms are more involved in industries with greater fixed assets and lower board independence. We document a positive relationship between family firm involvement and performance, which indicates a net advantage for family firm shareholders in industries where family firms congregate. However, we also find that family firm performance is negatively affected when family firms use more debt and maintain a higher control wedge than their industry counterparts.

Earnings Management and Corporate Governance in Family-Controlled Companies

Corporate governance literature advances the idea that certain aspects of board of directors' structure improve monitoring of managerial decisions. Among these is the managers' decision to manage earnings. Prior studies have shown that earnings management, in widely-held public companies, is less prevalent when there is a high level of board independence. However, there is less evidence on the effectiveness of board independence on earnings management in family-controlled companies. This issue is interesting in particular as such companies are susceptible to various types of agency concerns. It is the purpose of this study to shed light on the earnings management issue in family-controlled companies, characterized by a potentially low board independence environment. In this study, board independence is estimated by two parameters (i) proportion of independent directors on board, and (ii) lack of CEO/Board Chairman duality function, with special attention paid to the case where the CEO is a member of the controlling-family. Our empirical results provide evidence that, indeed, the impact of board independence on earnings management is weaker in family-controlled companies. The same effects are also found for the cases where the CEO is a member of the controlling-family, even though she is not also the Board Chairman.