Although the structure of the board of directors has been the topic of considerable debate and academic research over the past two decades, much of this prior literature focuses on aggregate measures of board composition such as board size or the fraction of independent outside directors. More recent studies recognize that directors with differing backgrounds and expertise are likely to bring different sources of value to the board. However, empirical studies of the importance of these attributes are limited by the ‘stickiness’ of board structures. Specifically, transactions costs associated with board structure adjustments can result in board structures that evolve only very slowly. As a result, observing board structures and their determinants at any given point in time can provide a misleading picture of how boards are formed; most notably, how and why particular individual directors are matched with the specific set of assets that they help govern.
In our paper, Matching Directors with Firms: Evidence from Board Structure Following Corporate Spinoffs, which was recently made publicly available on SSRN, we aim to overcome some of these limitations by analyzing board structure following corporate spinoffs. As part of the spinoff, a board of directors must be created from scratch for the spun off unit. This ‘de novo’ feature provides a unique opportunity to observe boards that are unlikely to be affected by the factors that contribute to the ‘stickiness’ of ongoing boards. In addition, the separation of one publicly traded firm into two publicly-traded firms leads to large discrete differences in asset and operating structure and significant variation in CEO identity and origin. This allows us to examine both the formation of new boards by the spun off units and the changes in parent board structure occasioned by a significant operational restructuring. Perhaps more importantly, our experimental design allows us to link specific assets with specific directors, thereby providing unique evidence on how directors are matched with the assets they govern. Similarly, by tracking the movement of individual CEOs and individual directors, our data can enhance our understanding of the extent to which individual directors are matched with specific CEOs.
We document significant differences in the boards of spun off units and the remaining parent firms relative to the original parent firms. Although these changes are economically most significant for the unit boards, the parent board exhibits significant changes in board composition as well. This implies that the large-scale restructuring of assets and management teams in a spin-off create a situation in which the benefits of altering board structure exceed the transaction costs of doing so. We also find that the board structures of the post-spinoff parent and unit firms differ substantially from each other. There is little overlap between the two boards and the majority of unit directors have no connection whatsoever to the parent firm.
Our analysis focuses primarily on the roles that director industry expertise and ties between individual directors and post-spinoff CEOs play in matching directors to firms. We find that the average post-spinoff unit firm has a much greater proportion of directors with expertise in its industry than did the pre-spinoff firm. We also find that the likelihood of a pre-spinoff parent director being placed on either the unit’s or the parent’s post-spinoff board is strongly positively related to whether that director has specialized expertise in the relevant industry. Overall, these findings support the view that firms that have the opportunity to form or significantly restructure their boards do so in a way such that specific directors are matched with operating assets for which they have unique monitoring and advising capabilities.
Finally, we find that prior ties between individual directors and CEOs also play a significant role in matching directors to firms. Post-spin-off unit and parent firms whose CEOs were previously the pre-spinoff parent CEOs have greater proportions of pre-spinoff directors on their post-spinoff boards than do other CEOs. Controlling for the specialized expertise of the director, the likelihood that an individual pre-spinoff parent director is selected for either the parent or unit board is positively associated with whether the pre-spinoff parent CEO becomes the CEO of that firm. This relationship holds whether or not the director was originally elected to the pre-spinoff board during the tenure of the pre-spinoff CEO. These results suggest that even in times of significant upheaval in firms’ operating and board structures, ties to the CEO are an important determinant of who serves on the board of directors.
The full paper is available for download here.