Chapter 6 Flashcards
(21 cards)
BoD responsibilities?
- are the hiring and firing of managers as well as monitoring and compensating management (compensation committee)
- Approve transactions that fundamentally change the company’s assets, financial or earnings situations, e.g., large corporate investments (M&As)
Germany, Austria, and Sweden, employees have the right to be represented on the board (several codetermination laws or Mitbestimmungsgesetze)
One vs Two Tier
Labor Representation
Risk-neutral investors might be able to credibly offer protection against shock to (risk averse) employees
Kim, Maug and Schneider (2018) investigate the hypothesis that labor participation helps improve risk sharing between employees and employers using a sample of German firms
Their results show that:
- skilled employees of firms with 50% labor representation on boards are protected against layoffs during adverse industry shocks
- unskilled blue-collar workers are unprotected against shocks
- employees pay an insurance premium of 3.3% in the form of lower wages
Codetermination
Board Committies
- audit committee
a. should review the scope and outcome of audit
b. should ensure the objectivity of auditors
c. bridge between independent external auditors and board (avoiding powerful executives becoming too close to auditors)
d. usually comprised of independent outside directors
e. Audit committees are mandatory in many countries (Australia, India, UK…) result of sarbanes-oxley act 2002 - renumeration committee
a. establishing formal and transparent procedure on top executive renumeration and renumeration packages of directors
b. size and structure of renumeration are important
c. no director should be part of setting his own renumeration - nomination committee
a. Makes recommendations on the appointment of new directors to the board
b. Idea is to prevent the board from becoming a cozy club, usually made of independent directors
c. provides a check and balance mechanism that reduces the possibility of a dominant director, pushing his candidates
Charkham (2005) describes the main rationale of sub-committees as follows:
- “Committees of the board are used for various purposes, the main one being to assist the dispatch of business by considering it in more detail than would be convenient for the whole board.”
- Sub-committees supposed to prevent decisions based on close social connections
- The most important committees should mainly be comprised of independent directors- Number and relevance of committees has increased over time
- Adams et al. (2021) document that while 25% of all director meetings occurred in (sub)committees in 1996, the percentage had risen to 45% by 2010
- Committee structures are positively related to board size and proportion of outside directors (Reeb and Upadhay, 2021)
Inside vs Outside directors
Outside directors:
- Neither work for the firm nor have extensive dealings with company
- Play larger role in monitoring management than inside directors
o Lower probability of collusion with top management (Fama 1980)
o Outside directors have incentives to protect and develop reputation as experts in decision control (Fama and Jensen 1983)
- Inside directors have better information
o Ravina and Sapienza (2010) examine the relative profitability of trades in their companies’ stocks made by outsiders and insiders insiders earn better returns
International finance corporation (IFC) defines independent directors
- Has no been employed by company or related parties in past 5 y
- Not affiliated with company that is an advisor or consultant
- Not affiliated with significant customer or supplier
- No personal contracts with company, senior management or related parties
- Not affiliated with non-profit that receives funding
- Does not participate in share option or pension plan
- Not served on board for more than 10 y
Independent vs Gray director
Independent director has no affiliation with comp other than directorship
No ties that could affect the exercise of objective
Gray director: An affiliated or connected non-executive (also termed “gray”) director is a director who, though not a member of the management, does have some relationship with the company
Problem with independent: committee may lead to interpersonal ties and longer director serves the more he may become dependent
Weisbach (1988) tested hypothesis that inside and outside directors behave differently in monitoring top management
- Outsider-dominated boards more likely to remove CEO
- Replacement of CEO
o Statistically significant inverse relation between firm’s market-adjusted share performance in a year and likelihood of subsequent change in CEO
o For outsider-dominated boards, responsiveness of removal decision to stock market performance is three times larger than for other board types
o Replacement decision takes place relatively quickly - Some papers find positive wealth effects surrounding outside director appointments (Rosenstein & Wyatt, 1990) others returns indistinguishable from zero (Lin et al., 2003)
− No consistent evidence for a better performance of outsider-dominated boards)
− Shareholders seem to attribute value to board independence (Nguyen and Nielsen, 2010
CEO Turnover
Neg relationship between CEO turnover and performance
Caveat
- Good corp. gov. vulture not necessarily equivalent to management dismissal
- Poor current performance may be due to past bad corp. gov performance
- Jenter and Kanaan (2015) show that CEOs are fired after bad performance caused by factors beyond their control
- Franks et al. (2001) find evidence that dismissals only occur in the lowest quintile of stock performance
- Firms often offer a face-saving rationale for a change in CEO rather than admit the CEO was forced out challenge for empirical studies to distinguish between forced and unforced turnover
Board Diversity
Gender Diversity
Board Size
Yermack (1996) argues that with increasing board size
- directors develop a free-rider mentality
- co-ordination problems arise
- discussions become less candid
Hypothesizes that firm performance decreases with board size. Empirically he finds:
- statistically significant and negative effect of board size on firm performance that is also economically significant: if board size doubles, nearly USD 600m shareholder value is destroyed on average
- that firms with smaller boards have a stronger relationship between poor performance and CEO turnover than do firms with larger boards.
− Finding consistent with the view that smaller boards are more vigilant overseers of the CEO than larger board
− Guest (2009) finds that board size has a strong negative impact on profitability, Tobin’s Q and share returns
− Cheng (2008) shows that larger boards are associated with lower variability of corporate performance
Board Busyness
Interlocked board
Interlocked directorships: Directors of different firms sitting on each other’s board → danger of collusion
− Hallock (1997, 1999) and Fich and White (2003) find that interlocked CEOs are more highly paid than other CEOs and that CEO turnover is lower in interlocked boards
− Devos et al. (2009) document that shareholders react negatively to the formation of director interlocks
− Zona et al. (2015) show that interlocks may be positively related to performance for resource-constrained firms
Combining CEO and Chairman Position
Staggered Boards
Former Executive on Supervisory Board
Board Independence
MOnitoring & Advice
