CEO outside directorships and their value to companies have been a topic of debate among a wide range of stakeholders, particularly investors, boards, and policy makers. Some argue that CEO outside directorships benefit a CEO’s own firm by opening valuable resources in other boardrooms and the corporate elite and by allowing first-hand insights into successful firm strategies. Others, particularly proxy advisers and some journalists, call connected directors “overboarded,” suggesting that outside directorships consume too much of a CEO’s time while remitting little or no value to the CEO’s own firm. Reflecting that criticism, S&P 500 CEO outside board assignments haves dropped from 52 percent to 37 percent over the last decade.
As attention on CEO overboardedness escalates, we wanted to explore the impact of CEO outside board assignments on managerial efficiency: The ability of managers, relative to their industry peers, to transform company resources into revenue. We identify a unique empirical setting where a CEO’s number of outside board seats is exogenously decreased by a merger that eliminates a board on which the CEO sites. We find that CEO outside board directorships have a negative impact on managerial efficiency. Specifically, we show that, after accepting a new board seat, an average CEO will drop to the bottom 25th percentile of managerial efficiency. Our finding indicates that efficient use of firm resources requires a clear focus on firm internal operations and an up-to-date understanding of industry trends, both of which require focus and time. Echoing the policy makers and the media, outside board appointments, therefore, can be viewed as an additional toll on the CEOs’ valuable time that affects their capacity to manage firm operations efficiently.
However, this is a simplistic view of outside board assignments that ignores the contingencies of board interactions. It is problematic to assume that all outside boards are similar and thus offer similar value to CEOs. Therefore, in exploring the impact of outside directorships on managerial efficiency, we consider the potential merits of host board capital, which refers to the resources that an outside board can provide and is a function of the skills, expertise, and social capital of its members. We consider access to peer CEOs and board diversity as two important proxies of host board capital that might compensate for some of the disadvantages of CEO outside directorships. Peer CEOs grant access to relevant and up-to-date experiences that help advance a CEO’s decision-making. In the same vein, host board diversity increases the CEO’s exposure to diverse resources, heterogeneous information, and wider networks. Our findings show that host boards with more CEO directors and more diverse board structures reduce the adverse effect of a CEO’s outside-board service on managerial efficiency.
The generally accepted view that outside board directorships advance executive interests at the expense of shareholder interests rests on the assumption that all outside boards have similar qualities. Examining this assumption by looking into the characteristics of the host board directors tells us that host board capital might reduce and in some cases even reverse the potentially detrimental effect of CEO outside directorships on managerial efficiency. More precisely, a host board with three or more CEO directors reverses the negative association between CEO outside directorships and managerial efficiency.
The trend of increasing the diversity of corporate boards also plays a key role in the value of CEO outside board assignments. We find that diversity, which we measure by gender, age, nationality, expertise, and tenure on a board, substantially limits the adverse effect of CEO outside directorships on managerial efficiency. Diverse boards offer a variety of perspectives. For example, women directors often have higher education levels and experience at smaller or non-profit firms. Similarly, national or cultural heterogeneity promotes a wider perspective on the board, leading to a better understanding of complex global relations. Directors with different cultural backgrounds also offer social connections beyond the current boardroom, expanding insights that improve many strategic decisions such as cross-border M&A. Directors with longer tenures tend to have stronger firm-specific knowledge and are better at facilitating communication whereas recently appointed directors are likely to offer fresh perspectives. Younger directors might have links to entrepreneurs whereas older directors might offer links to senior-executive networks.
It’s worth noting that Institutional Shareholder Services (ISS) recommends that CEOs serve on no more than two outside boards. What’s more, CEOs face growing scrutiny of how they spend their time outside of their company and pressure to avoid possible conflicts of interest with their choices. Given the heterogeneity in the characteristics of host boards, corporate boards should be more deliberate in reviewing outside board service requests by their CEOs. CEOs’ popularity in the director labor market gives them a high degree of flexibility in their choices of outside boards. CEOs may use this flexibility to either serve their self-interests and thereby forgo the strategic needs of their companies or serve on boards that provide crucial sources of learning and therefore fill the strategic needs of their own firms.
This post comes to us from professors Canan Mutlu and Sunay Mutlu, at Kennesaw State University and Steve Sauerwald at the University of Illinois at Chicago. It is based on their recent article, “CEO Outside Directorships and Managerial Efficiency: The Role of Host Board Capital,” available here.