Do Individual Directors Matter?

A fundamental question in corporate governance research is whether the board of directors affects firm value. Some argue that directors contribute no additional value to the firm and may even lower its value if they act only as a rubber stamp on the CEO’s decisions. However, the weight of evidence is that directors can increase value by, for example, using their experiences and connections to improve firm performance in specific settings.

Yet, largely absent from the literature is an investigation of whether individual directors possess unique characteristics that increase value, irrespective of which boards they sit on or the prevailing business conditions they face. The increasing scrutiny of board performance and the frequency with which lawyers and other professionals identify creativity, communication skills, integrity, and other soft skills as attributes of effective board members highlight the importance of filling this gap. That task is empirically challenging, however, because the very nature of these attributes makes them difficult for econometricians to quantify.

In a recent article, we overcome this limitation by creating a new measure of what we call director-specific quality (DSQ). DSQ captures any time-invariant, largely slow-moving, or previously learned value-relevant attributes of directors, and our analyses indicate DSQ explains 10 percent of the variation in firm value, which we capture with the ratio of a firm’s market value to its book value. While these director-specific attributes can reflect the usual observable traits that remain constant during a director’s tenure, such as early life and work experiences and gender, they also capture difficult-to-quantify characteristics that are transferable across firms and over time, such as critical thinking skills, grit, creativity, interpersonal skills, work ethic, and willingness to challenge management. In fact, while the customary director attributes often correlated with firm value, such as graduating from Ivy League schools, being diverse, and having prior managerial experience, are correlated with our estimates of DSQ, they explain less than 0.2 percent of variation in DSQ. Further, our estimates of DSQ capture the unique contribution of specific directors to firm value that is not contingent upon board interactions or particular settings.

In addition to showing that DSQ explains a nontrivial amount of the variation in firm value, we further validate whether DSQ captures transferable, director-specific, and value-relevant attributes by examining whether DSQ is correlated with other measures of value and director performance. We show that high DSQ directors receive more shareholder support during elections than low DSQ directors and are significantly less likely to receive less than 90 percent shareholder approval. We also document that the appointment of high DSQ directors tends to boost a company’s share price and that the death of high DSQ directors tends to lower it.

We also examine whether boards with higher average DSQ make decisions that increase firm value. Our findings suggest that high DSQ boards facilitate better decisions by helping set and ultimately approving a firm’s strategic direction, providing advice on potential acquisition targets, designing compensation packages that better align CEO incentives with shareholders’ interests, and preventing managers’ misuse of firm resources. Specifically, we find that companies whose boards have higher average DSQ scores make more value-increasing M&A deals, tie CEO compensation more closely to firm performance, produce more and higher quality innovation, and perform better as stewards of shareholder capital. During the COVID-19 pandemic, the stock returns of such companies were also relatively higher.

Our study extends work examining the relevance of boards to firm value. We present a methodology that identifies value-relevant and director-specific effects that are transferable across firms and over time. These unique attributes are distinct from board structure or director traits associated with context-specific valuation effects found in existing studies. Importantly, DSQ is unique to the director, and therefore our findings have implications for the discussion on whether directors matter, what makes an effective board, and how boards should be structured. Our results suggesting that boards with higher average DSQ make better decisions imply that who is on the board matters maybe as much or even more than board structure – the focus of many governance studies. Our results suggest that director-specific skills other than easily quantifiable traits like gender or other time-varying traits may be important in aiding firms and shareholders in selecting directors who will strike the right balance between monitoring and advising and will build trust and promote productive discussions and good decision-making. Overall, our findings suggest that director-specific attributes are important drivers of value, are related to good decision-making, and should be considered when establishing and assessing policy.

This post comes to us from Dipesh Bhattarai, Matthew Serfling, and Tracie Woidtke at the University of Tennessee, Knoxville. It is based on their recent article, “Do Individual Directors Matter? Evidence of Director-Specific Quality,” available here.