“Presumably, the independent directors working in concert with the well-informed internal management directors effectively monitor and control the firm’s strategic business activity,” the authors write. “Alternatively, gray directors’ potential conflict of interest may work at cross purposes, thereby inhibiting effective corporate governance and control.”
In fact, bankrupt companies had many more gray members serving on both their audit and compensation committees, among the most powerful perches a director can have to exert control over the board and its corporate strategy.
Some other findings: The CEOs of solvent companies were typically older by several years than their counterparts at bankrupt firms, as were the directors, on average. With greater age also came increased experience; the board members of non-bankrupt companies sat on more boards than their peers at failing firms. In addition, both types of outside directors of non-bankrupt boards owned less stock in the company on whose board they sat, on average, than their peers at bankrupt companies did.
Interlocking boards, or those that have at least one member in common, have been widely denigrated, and such links have long been illegal in the U.S. among firms competing in the same industry. But for those in different markets — as in the case of an automaker’s director holding a position on a steel company’s board — the ties are permitted and seen as beneficial, because they can potentially facilitate the flow of information across related industries.
This study lends credence to the latter theory, finding that non-bankrupt firms had a significantly higher percentage of interlocked directors across related industries (1.6 percent) than did companies that went under (0.3 percent). By obtaining information that helps their firm glean knowledge from others experiencing downturns in similar industries, the authors argue, directors can help steer their companies clear of financial ruin.
Having sitting CEOs on the board is also beneficial. Companies that did not go bankrupt had 1.49 directors, on average, who were serving as CEO of another firm, compared with a significantly lower number (1.10) among those that went bankrupt. Although sitting CEOs are often regarded as a threat to a company’s leadership, their strategic knowledge can also aid in decision making, the findings suggest.
Finally, a higher percentage of solvent firms’ boards were staggered, meaning they held elections for only some of the members each year — an approach that presumably wards off raiders and allows companies to take a longer-term strategic view.
The authors advise firms to take the findings into consideration when reconfiguring or expanding their boards, replacing retiring members, or leading searches for new directors. In doing so, it’s imperative that companies recognize the “corporate governance factors that distinguish between healthy firms and those that fail.”
A company’s board can play a major role in a firm’s ability to avoid bankruptcy. A larger and older board with more sitting CEOs and independent members, who typically own less stock in the company, is better equipped to lead the firm through difficult economic challenges.