The Market for Non-Executive Directors: Does Acquisition Performance Influence Future Board Seats?

The Market for Non-Executive Directors: Does Acquisition Performance Influence Future Board Seats?

Marc Goergen, Svetlana Mira, Noel O'Sullivan

March 15 2018

Starting with the 1992 Cadbury Report, successive UK codes of best practice in corporate governance have emphasised the key role that non-executive directors play in making sure that executives run their company in the interests of the shareholders. Regulators from other countries, such as France and the USA, have followed suit by similarly highlighting the importance of non-executive directors as well as pushing for a greater percentage of such directors on corporate boards. It may then come as a surprise that there is little or no evidence in the academic literature that a greater percentage of non-executive directors on the board improves firm value and firm performance.

Have regulators’ efforts been ill-advised and in vain? Should regulators have focused on other aspects of corporate governance rather demanding via successive codes of best practice that boards appoint more non-executive directors? Not necessarily as academic literature that has investigated the labour market for directors has found that non-executive directors do seem to matter after all. This literature originates with a seminal paper by Eugene Fama and Michael Jensen who argued that the labour market incentivizes directors to look after shareholder interests. It does so by rewarding good directors with additional future directorships and by penalizing bad directors with fewer such future positions. The first studies of this literature focused on executive rather than non-executive directors. These studies tend to conclude that executives are rewarded for good performance with more future non-executive board positions. In contrast, executives behind dividend cuts are penalized by the labour market as they end up holding fewer non-executive positions.

More recent studies have focused on the labour market for non-executive directors. These studies investigate whether the quality of monitoring provided by the non-executive directors affects their future career. In other words, are non-executive directors who are good monitors rewarded and those who are bad monitors penalized? Although a recent study by Steven Davidoff and co-authors suggests that non-executives of underperforming financial institutions were not penalized in the aftermath of the 2007-8 crisis, the few other extant studies tend to provide evidence in favour of a labour market for non-executive directors.

We contribute to this literature by studying whether the monitoring quality provided by non-executive directors around a specific type of corporate decision affects the future careers of the non-executives involved. We study acquisition decisions made by UK listed companies between 1994 and 2010 and follow the number of non-executive directorships held by the non-executive directors involved up to five years after the acquisition. Hence, our research period effectively ends in 2015. There are at least two benefits from focusing on acquisition decisions. First, acquisitions are one of the most important decisions made by boards of directors. Second, acquisitions are discrete events which enable shareholders to assess their consequences for firm value and performance. There are also benefits from studying the UK. First, during the period of study successive codes of best practice pushed UK companies to appoint more non-executive directors. Second, director turnover on UK corporate boards is not restricted as is the case for the majority of US corporate boards, which are staggered boards. Finally, while for US boards it is not always clear whether an individual director assumes an executive or non-executive role or both, successive UK codes of corporate governance have pushed for a clear separation between the two roles by clarifying the monitoring role of non-executive directors and also by discouraging CEO-chair duality. Hence, the UK labour market for directors should be much more market oriented and suffer from fewer restrictions than the US labour market for directors.

We distinguish between good and bad post-acquisition performance, based on stock market and accounting performance as well as dividend changes. While we do not find that the former two types of performance measures affect the future careers of the non-executive directors, we observe that dividend increases have a positive effect on the number of directorships that the non-executive directors hold five years after the acquisition whereas dividend omissions and cuts have a negative effect.

Why would dividend changes have an impact on the future careers of non-executive directors while accounting and stock market performance does not have any such impact? We propose three reasons for this result. First, investors tend to consider dividends to be more tangible than e.g. capital gains, which are only realised once they sell their shares. Second, dividends tend to be sticky as managers prefer not to change dividends unless they believe that there has been a long-term change to profits which warrants a permanent dividend increase or decrease. Finally, dividends also assume a corporate governance role as high dividends reduce the free cash flow that managers may be tempted to waste and they also force companies to return to the stock market regularly to raise funds, thereby exposing themselves to the scrutiny of outsiders.

Our study is an important contribution to the debate about the role and value of non-executive directors on corporate boards. It suggests that the labour market for non-executive directors rewards those directors who are good monitors and punishes those directors who are bad monitors.

Authors

Real name: 
Svetlana Mira
Real name: 
Noel O'Sullivan
School of Business and Economics, Loughborough University