The silver lining on multiple directorships?

The silver lining on multiple directorships

Thursday, Jun 12, 2014

Lee Kin Wai

The Straits Times

It is generally believed to be detrimental for a company if its board directors hold several other board positions elsewhere.

The idea is that a director is less likely to be able to effectively oversee a firm if he is too busy with similar responsibilities for many other organisations.

Hence, directors who sit on multiple boards often attract more regulatory scrutiny amid an increased emphasis on corporate governance.

Yet this theory of multiple directorships being harmful to a firm may not be universally true.

A recent study I conducted with Professor Lee Cheng Few of Rutgers Business School found that multiple directorships can actually be positive for certain types of firms.

It depends on the characteristics of the firm, and the regulatory environment in which it operates.

The argument against

In general, Asian companies are significantly more likely than American ones to have directors who sit on multiple boards.

Studying 1,482 firms listed in Hong Kong, Indonesia, Malaysia, Philippines, Singapore and Thailand, over the period from 2001 to 2007, Prof Lee and I found that multiple directorships are far more prevalent in East Asia than in the United States.

In Asian companies, 43 per cent of outside directors hold at least three board seats, more than double the 21 per cent in the US.

Outside directors are members of a company’s board of directors who are not employees or stakeholders in the company. They are paid an annual retainer fee.

Yet research has shown that multiple directorships have an overall negative impact on firm valuation, as measured by the market value of their shares to their book value (the value of their assets according to their balance sheets).

This ratio measures the price of a company’s shares in relation to its net assets.

In our sample, multiple directorships decreased shareholder value, on average, by between US$50 million (S$62.6 million) and US$130 million – equivalent to between 1 per cent and 4 per cent of equity valuation.

Put another way, firms with directors sitting on several boards were less valuable precisely because of that factor.

The drag is greater for companies where ownership is concentrated and controlled by a large dominant shareholder.

Valuations of such firms were impaired by between US$70 million and US$165 million, or between 2 per cent and 4 per cent of equity valuation.

This could be because in such cases, there is greater potential for a conflict of interest between the controlling and the minority shareholders.

Thus, if the firm’s directors are seen as being overstretched, their ineffective monitoring of the firm is felt more acutely.

Multiple benefits

Why, then, do Asian firms tend to appoint busy directors to their boards?

As it turns out, there are two types of companies that benefit from having directors with multiple directorships: those that have high advising needs and those that need to raise a lot of money.

Firms with high advising needs may rely on their directors for business networking contacts and for advice on strategic business imperatives.

These companies tend to be large and operate across many industry and geographic segments. Directors who sit on multiple boards will thus be a boon as they bring with them a wide range of experience.

Such directors have broad knowledge of business best practices, critical success factors and the potential pitfalls associated with diversification, market expansion, mergers and acquisitions, and other business strategies.

Indeed, we found that multiple directorships raised the valuation of companies with higher advising needs by between US$43 million and US$61 million, or approximately 1 to 1.5 per cent of equity valuation, compared to firms with lower advising needs.

In other words, the negative effect of having busy directors is more than offset for firms with high advising needs.

As the average number of directorships per external director for such firms increases, their market value-to-book value ratio also rises.

The benefit is greater for firms with broader ownership than those that are closely held.

A similar phenomenon can be seen for companies that frequently turn to capital markets to raise funds, although the effect is smaller.

Among companies with greater external financing needs, those that have directors holding multiple directorships enjoyed higher valuations of between US$45 million and US$60 million.

Each increase in the average number of directorships per external director for such firms by one standard deviation sends their market value-to-book value ratio up by 1.1 per cent compared to our sample average.

This is possibly because firms that often tap capital markets are subject to heightened scrutiny by bankers, investors, analysts and other market participants. This motivates even busy outside directors to pay greater attention to their board duties.

Their personal reputations as good monitors and managers are on the line. If they fail to stop the firm from investing funds raised from the market into value-destroying projects, their own careers in the wider corporate world may suffer.

Systemic factors

Beyond individual firm characteristics, governance and institutional features also have a bearing on the effect of multiple directorships.

In markets with weak enforcement of shareholder rights, firms with directors who hold several directorships see greater declines in their value due to the poor monitoring attributed to busy boards. This is combined with problems associated with a concentrated ownership structure.

Conversely, in more developed markets that better support shareholder rights, the beneficial effect of multiple directorships for firms with high external financing needs is more positive.

Thus, while divided attention can erode a director’s ability to perform his duties well, a wide demand for his oversight services does signal his propensity to provide valuable contributions.

Established companies, which operate in strong regulatory regimes and have well-entrenched corporate governance practices, may find that the value of busy directors’ experience, expertise and contacts outweighs their time constraints.

Given the rising focus on board independence across Asian markets, we recommend care and caution in balancing the monitoring and advisory roles of directors.

It is vital to take into account the heterogeneity in firm characteristics, shareholder rights and corporate ownership structures in the design of optimal board structures. This is especially so for regulators considering formal restrictions on directors serving on multiple boards.