In the United Kingdom, successive codes of best practice in corporate governance have highlighted the important role of outside or non-executive directors in ensuring that corporations are run for the benefit of their shareholders. While the first code of best practice, the 1992 Cadbury Report, recommended that there should be a sufficient number of non-executives on the board, the 2003 Higgs Report was much more prescriptive, recommending that there should be a majority of non-executives on the board (excluding the chairman). Similarly, U.S. regulation has been emphasizing the important role of independent or non-executive directors. More specifically, the NYSE and NASDAQ listing rules require companies to have a majority of independent directors.
Despite many national regulators pushing for greater non-executive presence on boards, there are few academic studies finding evidence that a greater proportion of non-executives improve firm performance or value. Indeed, most studies do not find any significant impact of non-executives, and at least one study even finds a negative effect.
Does this mean that non-executive directors do not matter, that the efforts of regulators have been misguided? One strand of research, which has found that non-executive directors have value, has been studying the labor market for directors. Eugene Fama and Michael Jensen were the first to point out the role of this market in giving directors incentives to create shareholder value. The question that arises is whether this market rewards directors perceived as doing a good job with more future board positions and penalizes those perceived as doing a bad job with fewer board positions. The earliest such studies have focused on executive directors rather than non-executives. Typically, these studies have found that directors, who performed well during their executive careers, end up holding more non-executive directorships. There is also evidence of the disciplinary role of this market, as executives who cut their firm’s dividend are penalized by holding fewer non-executive board seats.
What about the market for non-executive directors? Evidence suggests that the labor market rewards non-executives who are good monitors, as evidenced by their willingness to fire badly performing CEOs. In turn, they are punished for being ineffective monitors, as evidenced by the few board seats they hold if their firms have been sued for financial fraud. Nevertheless, a recent study by Steven Davidoff and colleagues on the effects of the 2008 subprime mortgage crisis does not find any evidence that the labor market punished non-executive directors of badly performing financial institutions.
Our study focuses on UK firms making acquisition decisions as we are interested in ascertaining how the quality of such decisions affects the future careers of the non-executives involved. Acquisitions are not only one of the most important strategic decisions made by boards, but also represent a discrete event allowing shareholders to assess their wealth effects. We study UK firms that completed at least one acquisition between 1994 and 2010. We focus on UK firms for a number of reasons. First, and as discussed above, during our period of study successive codes of best practice put more emphasis on the monitoring role of non-executives in corporate governance, resulting in a greater percentage of such directors on boards. Second, these successive codes of best practice also discouraged CEO-chair duality, recommending that the roles of the CEO and the chair of the board of directors should be assumed by two separate individuals. This results in a clear delineation between the roles of executives and non-executives in the boardroom. Finally, in contrast to the U.S., where the majority of firms have staggered boards restricting shareholders from removing certain directors at a given time, there are no such restrictions concerning UK boards.
We follow our firms for five years after the acquisition has been completed. Hence, our research period effectively ends in 2015. We investigate whether the post-acquisition performance of the acquirers affects the future career of the non-executives in place during the year of the acquisition. More specifically, we study whether post-acquisition performance of the acquirers affects the number of board seats that the non-executives hold five years after the completion of the acquisitions. We use a number of performance measures, including accounting performance, market performance and dividend payout.
We do not find that post-acquisition accounting and market-based performance have any effect on the number of board seats held by the non-executives on the board of the acquirer. We do, however, find that dividend cuts and omissions reduce the number of board seats the non-executive holds, and dividend increases augment that number. How can we explain our findings that the post-acquisition dividends affect the careers of the non-executives, whereas other measures of performance do not? First, dividends are more tangible for most investors, as they are associated with cash in hand whereas capital gains, for example, are only realized once a stock has been sold. Second, as James Lintner’s interviews with managers in the 1950s suggest, managers are very reluctant to change the dividend. Hence, any such change is likely to be much more salient than changes to other performance measures. Finally, shareholders do not value dividends only because they are a regular source of cash, but also because they address Michael Jensen’s free cash flow problem by reducing retained profits and by forcing firms to return to the stock market more often for financing, thereby subjecting themselves to the regular scrutiny of the capital markets. We also show that acquirers pay out the extra value created by the acquisitions to their shareholders via increased dividends. Bad acquisitions, which are associated with negative stock market performance, result in dividend cuts, or even omitted dividends, five years after the acquisition. Finally, we show that a bad acquisition is unlikely to have an immediate, detrimental effect on performance, as its effect on a non-executive’s career is gradual. Hence, our study suggests that dividends matter and should be accounted for when exploring the impact of post-acquisition performance on the future careers of non-executive directors.
This post comes to us from Professor Marc Goergen and Dr. Svetlana Mira at Cardiff Business School, Cardiff University, and Professor Noel O’Sullivan at Loughborough University’s School of Business and Economics. It is based on their recent paper, “The Market for Non-Executive Directors: Does Acquisition Performance Influence Future Board Seats?” available here.