Authors: Aiyesha Dey (University of Minnesota) and Xiaohui Gloria Liu (University of Texas at Dallas)
Publisher: Working paper
Date Published: March 2011
Previous studies have found that the longer a CEO remains at a firm, the more influence he or she has over the makeup of the board of directors and the decisions the board members make, which can have major implications for a company’s strategic direction and performance. One obvious worry is that a long-serving CEO will maneuver his or her own close associates onto the board, and thus be subject to little oversight.
But this study finds that although a board’s independence may indeed diminish if a CEO remains in charge for a long time, other attributes of the board can be quite positive, and those attributes often more than outweigh the loss of independence. For one thing, when long-tenured CEOs use their increased control to add directors who are like-minded or with whom they share social ties, the improved communication can lead to better firm performance and increased shareholder value. In addition, veteran CEOs are more likely than others to have educationally diverse and experienced boards that provide better strategic advice, resulting in improved innovation efforts and investment outcomes. (The researchers define long-tenured CEOs as those with 10 or more years on the job.)
New board members are technically chosen by nominating committees, the authors note, but research has shown that in practice, chief executives have a large say in their selection. CEOs who are successfully running the company and stay on tend to increase their leverage with the board. Over time, these CEOs are likely to have more input and power over the makeup of the board, structuring it to match their goals.
To explore the connections between board composition, CEO tenure, and firm performance, the researchers analyzed several databases covering 1,347 large firms (with average annual sales of US$6.6 billion) from 1996 through 2006. The companies represented a cross-section of industries, including manufacturing, business equipment, healthcare, wholesale and retail services, and utilities, as well as the financial sector.
The researchers obtained corporate governance data from RiskMetrics (previously named the Investor Responsibility Research Center); information on CEO tenure and directors’ appointments from ExecuComp; biographical information and social network data on directors and senior executives from BoardEx of Management Diagnostics Limited; and firm characteristics and stock return numbers from Compustat and the Center for Research in Security Prices (CRSP).
To complete their assessment of whether a firm was innovative and successful under its CEO, and whether the chief executive had a board that pursued a path beneficial to shareholders, the researchers used patent data from the National Bureau of Economic Research. The data included the number of patents obtained during the CEO’s tenure; the quality of the patents (as measured by others’ citations); and spending decisions on research and development, capital projects, and acquisitions. Lastly, the researchers examined whether shareholders were being rewarded, by analyzing the contribution of R&D expenditures and other investments to returns.
The researchers looked at innovation because it is a long-term activity that has both high risk and a potential for large returns; it requires the initiative of a leader; and, most importantly, it benefits from the advice of a board and requires board approval. The study found that more successful CEOs (in terms of firm performance) were also associated with higher levels of innovation, which is consistent with the idea that CEOs with a long and strong track record don’t worry about being replaced and are more likely to pursue longer-term projects to boost shareholder value.
Overall, the authors found that CEOs with longer tenures do have more social ties — including shared alma maters, past employment at the same firm, overlaps in military service, and memberships in the same clubs and charities — with the directors who sit on their boards than do newer CEOs. Longer-serving CEOs also have more directors who sit on multiple boards; who either were or are C-level executives; and who have business, law, finance, or accounting degrees. According to the authors, this is an indication that longer-term CEOs are comfortable with more educated and experienced directors, those who offer a wider breadth of knowledge and can enhance the quality of boardroom discussions with varied points of view.
The researchers conclude that long-term CEOs are not seeking to turn their boards into rubber stamps. Rather, they use their personal ties, and their directors’ wide perspectives and experience, to get valuable input that pays off in higher-quality innovation and better overall firm performance.
Long-tenured and successful CEOs tend to have boards filled with like-minded directors with whom they have social ties. But these directors also tend to have more experience and more diverse backgrounds than their counterparts in companies led by CEOs with less tenure. Although they may not have as much independence as their counterparts, these directors are often better advisors and are catalysts for improved innovation and investment performance.