BOARD SEAT ACCUMULATION BY EXECUTIVES: A SHAREHOLDER S PERSPECTIVE. * Arizona State University, College of Business, Tempe, AZ 85287, USA.

Transcription

1 Working Papers R & D BOARD SEAT ACCUMULATION BY EXECUTIVES: A SHAREHOLDER S PERSPECTIVE by T. PERRY* and U. PEYER** 2002/102/FIN * Arizona State University, College of Business, Tempe, AZ 85287, USA. ** Assistant Professor of Finance, INSEAD, Boulevard de Constance, Fontainebleau Cedex, France. A working paper in the INSEAD Working Paper Series is intended as a means whereby a faculty researcher's thoughts and findings may be communicated to interested readers. The paper should be considered preliminary in nature and may require revision. Printed at INSEAD, Fontainebleau, France. Kindly do not reproduce or circulate without permission.

2 Board seat accumulation by executives: a shareholder s perspective Tod Perry Arizona State University College of Business Department of Finance Tempe, AZ Tel. (480) Tod.Perry@asu.edu Urs C. Peyer INSEAD Department of Finance Boulevard de Constance Fontainebleau, France Tel Urs.Peyer@insead.edu September 2002 We have benefited from helpful comments from James Booth, Marc Zenner, and seminar participants at HEC Paris. We also thank Hal Bosher, Sumit Jamuar, and Swaminathan Kalpathy for research assistance. Tod Perry thanks the Investor Responsibility Research Center for help in obtaining some of the board data used in this study.

3 Board seat accumulation by executives: a shareholder s perspective Abstract The National Association of Corporate Directors and the Council of Institutional Investors have issued guidelines suggesting restrictions on the number of outside directorships for corporate executives with full-time jobs. We provide evidence supporting such guidelines by examining stock returns for 216 publicly traded sender (executive s main employer) and receiver (where the executive is an outside director) firms at the announcement of new outside director nominations. While average sender firm announcement returns (CAR) are negative, there is no significant relation between the number of directorships the executive already holds and CARs. However, in additional tests, we find that the number of directorships proxies for busyness as well as a signal of quality of the executive. We show that for sender firms where the executive s time is more valuable, e.g., firms with greater growth opportunities, the announcement returns are negatively related to the number of directorships already held by the executive. We argue that this evidence is consistent with a busy hypothesis. On the other hand, we find a marginally significant positive relation between the number of directorships and CAR for low growth sender firms and executives with shorter track records, consistent with a signaling hypothesis. The negative association between the number of directorships and shareholder value remains even after controlling for the expected number of directorships and for diversified shareholders who hold a value-weighted portfolio of the sender and receiver firms. We interpret our findings as consistent with executives choosing to serve on outside boards as a form of perquisite consumption at the expense of shareholders.

4 1 Introduction Corporate governance failures have been blamed for the recent losses of shareholder value in a number of companies including Enron, Global Crossing, and MCI-Worldcom. A common criticism of the current system is that directors are over committed or too busy to monitor management effectively. One proposal intended to improve monitoring by the board is designed to restrict the number of directorships one person may hold. For example, the National Association of Corporate Directors (NACD) issued guidelines in 1996 relating to director professionalism and conduct, including a recommendation that senior corporate executives and CEOs should hold no more than three outside directorships. The corporate governance policies of the Council of Institutional Investors (2002) suggest that individuals with full-time jobs should not serve on more than two other boards and a CEO should only serve as a director of one other company, and do so only if the CEO's own company is in the top half of its peer group. Outside directorships require significant time commitments by executives -- Blackhurst (2000) estimates as many as two full workdays per board meeting plus another two days per committee meeting. The NACD even recommends to budget at least four full 40-hour weeks of service for every board on which [the directors] serve. 1 Managerial ability is a scarce resource, and the time and effort expected of managers to monitor firms will generally reduce the time committed to the executive s own firm. An article in the USA TODAY claimed that one recent candidate for a 1 As cited in Byrne, J. and R. Melcher, The best & worst boards, Business Week, November 25, p 102. Business Week also assigned lower corporate governance rankings for firms where outside employed directors hold more than three board seats. 1

5 directorship was overruled by her own board and told to stick to the business she was being paid to run. 2 Although limiting the number of outside directorships held by an individual director is widely supported by the governance reformers, the empirical evidence relating to the impact of busy directors is mixed. Core, Holthauser, and Larcker (1999) find that CEO pay is excessive in firms where board members are busy, i.e., hold three or more outside directorships, suggesting that busy boards might not monitor management effectively. Ferris, Jagannathan, and Pritchard (2002), however, investigate the frequency of subsequent securities fraud lawsuits and firm performance and find no evidence to support the busyness hypothesis. They conclude that the empirical evidence does not support limiting the number of directorships. Loderer and Peyer (2002) even find a positive association between firm value and the number of directorships the Chairman holds for a sample of Swiss firms. These papers focus on the relation between characteristics of the board and valuation of the firm. In this paper, we test the relation between the number of outside directorships held by executives and firm value in a more direct way by examining the impact of multiple directorships to the publicly traded firms that supply executives as outside directors to other firms. 3 We call these firms sender firms. Specifically, we relate the cumulative abnormal returns (CAR) around the announcement that an executive accepts an additional outside directorship to the number of prior directorships. If outside directorships constrain the time available for executives to manage their own firm, we expect a negative relation between the announcement return for sender firms and the number of directorships held by the executive. We refer to this as the busy hypothesis. On the other hand, Fama (1980) and Fama and Jensen (1983) 2 Boards find it harder to fill hot seats, by James Cox, USA TODAY, July 31, 2002, B1. 3 Booth and Deli (1996) also focus on the supply of outside directors. 2

6 have argued that the number of directorships can signal managerial quality. If executives signal their quality by accepting outside directorships, we would expect a positive relation between the number of directorships and announcement returns. We call this the signaling hypothesis. We collect 216 announcements of new director appointments in the years where both the sending firm, i.e., the firm where the executive or Chairman is employed, and the receiving firm, i.e., the firm that the individual is nominated to join, are publicly traded. In this sample, approximately 10% (25%) of the events involve individuals with three (two) or more outside directorships, proportions that are generally consistent with the distribution of directorships reported by Ferris et al. (2002) for the year We find that the average announcement return for the threeday period around the earlier of the press release or proxy filing date is a significantly negative 0.46% for the sending firms, which is consistent with the negative returns for sender firms reported by Rosenstein and Wyatt (1994). This result indicates that shareholders of sending firms, on average, lose money when one of their executives joins the board of another company. In a multivariate framework, we do not find a significant relation between sender firm CAR and the number of directorships held by the nominee. However, the number of directorships can be a proxy for both the quality and the busyness of a director. These hypotheses imply opposite effects on shareholder value. In order to distinguish between these two interpretations, we try to isolate the signaling effect from the busy effect. Because an executive s time and effort are finite, we expect that shareholders of sender firms with greater investment opportunities will suffer more if their managers accept additional outside directorships. We use both market-to-book and capital 3

7 expenditures to assets as proxies for growth opportunities of the sender firm and find that shareholders of high-growth sender firms suffer greater losses when their executives sit on more outside boards. In addition, we find that individuals at the center of the decision making process, namely the CEOs, are associated with more negative announcement returns when accepting additional outside directorships. On the other hand, if executives of firms with less investment opportunities find it more difficult to signal their quality by making investment decisions, then accepting outside directorships may be an effective means of signaling quality. Kaplan and Reishus (1990), Gilson (1990), Shivdasani (1993), Booth and Deli (1996), Brickley, Coles, and Linck (1999), and Ferris et al. (2002) all report evidence consistent with the positive relation between the number of directorships and director quality. We find evidence of a positive relation between CAR and the number of directorships for executives of firms with below-average growth opportunities. However, this effect is limited to younger executives, which is consistent with signaling to resolve uncertainty about managerial quality due to a shorter track record. It is also consistent with older executives indulging in more perquisite consumption because of a horizon problem. We find additional support for an agency cost or perquisite consumption interpretation because the announcement effect is more negative in firms without an independent board and firms where the executive owns less of the sender firm s stock. The relatively weak evidence in favor of the signaling hypothesis raises the question whether our results would differ if we controlled for the expected number of directorships. We test this in a two-stage framework. In the first stage, we predict the optimal number of directorships using a framework similar to Booth and Deli (1996). In the second stage, we replace the actual number of directorships held with the 4

8 difference from the predicted number (excess number of directorships). However, the results do not change significantly. In sum, we find that the number of directorships an executive holds has a significant effect on the sender firm s shareholder value negative if the firm has more growth opportunities, positive otherwise. Focusing on the receiver firms, we find that a firm adding outside directors to the board benefits from the announcement of an outside director nomination when its board is not independent and when it has poor prior performance. This benefit to the receiver firms is consistent with prior work of Baysinger and Butler (1985), Weisbach (1988), Rosenstein and Wyatt (1990), Byrd and Hickman (1992), Brickley, Coles, and Terry (1994), and Cotter, Shivdasani, and Zenner (1997). This raises the question of whether a fully diversified shareholder would care that an executive joins the board of another firm given the potential that the shareholder s losses in the sender firm are offset by gains or benefits in the receiver firm, particularly if management expertise and skill are scarce resources. Using the market-valueweighted sum of the announcement returns for sender, receiver and other firms where the nominee sits on the board, we find that executives of high growth sender firms with more directorships on average are associated with negative announcement returns across the portfolio of firms in which he or she is involved as a board member. For example, our regression results suggest that if a high growth firm CEO, age 62 or older, holds two outside directorships and accepts a third board seat, the portfolio CAR will be 5.2%. Our results are consistent with the interpretation that executives of high growth firms accept additional directorships for their own personal gain at the expense of the shareholders, thus potentially warranting a limitation on the number of directorships. 5

9 We begin in section 2 with a description of the sample and data. In section 3, we describe the empirical tests and present the results. We conclude in section 4. 2 Sample Selection and Data Description 2.1 Sample Selection We select a sample of new director appointments in the following manner. First, we identify a subset of publicly traded firms listed on Compact Disclosure in both 1995 and 1996 with available data from Execucomp and from a database provided by the Investor Responsibility Research Center (approximately 1,000 firms). Next, we identify individuals that were listed as directors in 1996 but were not listed in Using the proxy statements from Lexis-Nexis, we search each prospective director appointment to determine if the individual was actually added to the Board of Directors of the receiver firm during the prior year. For each observation, we collect both the proxy filing date and the date of the earliest announcement of the nomination or election of the new board member and additional information relating to the receiver firm and the individual director. We eliminate events where the new appointment is an employee of the receiver firm and events where the director represents a large ownership position or blockholder, as indicated in the news announcement or proxy statement. We also exclude announcements of new appointments that are related to an announced takeover, merger, or major restructuring. The selection process results in a sample of 471 events where we can identify the occupation of the director appointed or elected to the board, of which 216 events involve individuals employed by another publicly traded firm with data available on CRSP and Compustat. Almost all of the remaining director appointments are individuals that are retired executives, lawyers, consultants, academics or executives of private companies. Because the main focus of this paper relates to the impact of the appointment announcement on the sender firm, 6

10 i.e., where the director is otherwise employed, we do not exclude announcements where more than one director appointment is announced on the same day. 4 We designate the firm for which the individual is either an executive officer or Chairman of the Board as the sender firm for each director appointment. 2.2 Data Description The distribution of the events by month of the year is shown in figure 1, with event dates reflecting the earlier of either the proxy filing date or the announcement date. In our sample, 61% of the events have a distinct announcement date prior to the proxy filing date. 5 We observe the highest concentration of events in March (55 observations), which corresponds to the typical proxy season for firms with a December fiscal year-end. In panel A of table 1, we report the individual s position in the sender firm. 52% of the new directors in our sample are CEOs, 43% of the individuals hold the position of Chairman of the Board in the sender firm, and 39% hold other positions at the sender firm, such as president, CFO, or COO. In 34% of the sender firms, the individual being appointed to the additional board holds both the CEO and Chairman title in the sender firm. The average age of a nominated director in our sample is 54, and 12% of the new directors are between age 62 and 66 (not shown), which corresponds to the typical retirement age for many CEOs and other executive officers. The characteristics of the sender and receiver firms in our sample are summarized in panel B of table 1. We find that the average sender firm is significantly larger in terms of market capitalization, however, 41% of the events involve an individual from a 4 Our final sample contains 15 events where two or more individuals join the same receiver firm and the announcements were made on the same day. Excluding these events does not change the findings reported below. 5 Shivdasani and Yermack (1999) report that 76% of their director appointment events have distinct announcement dates before the filing date. If we restrict our sample to those events where we have both dates available, we find that 75% of our events have an announcement date before the proxy filing date. 7

11 smaller firm joining the board of a larger firm. Compared to the S&P500 firms, both sender and receiver firms display lower average market values but about the same level of average sales. Sender firms have significantly higher stock returns prior to the event, as measured by the stock return over the days [-250, -20] adjusted by the industry average return (measured at the 2-digit SIC level). Rosenstein and Wyatt (1994) find similar results for a sample of sender and receiver firms from 1981 to Our results are also consistent with the findings of Booth and Deli (1996) and Brickley, Coles, and Linck (1999), who show that retiring CEOs have a higher likelihood of obtaining subsequent outside directorships if their own firm performed well. Accounting performance (ROA) and measures of growth opportunities do not differ statistically across the two groups, however the firms in the sample underperform both S&P500 firms and the Compustat universe. For receiver firms, this underperformance is consistent with prior research showing that firms add outside directors following poor performance (e.g. Hermalin and Weisbach, 1988). 2.3 Number of Directorships A key variable for our tests is the number of directorships an individual holds prior to the appointment under consideration. We collect this information from the proxy statements of the receiver firm and the news announcements. While the SEC only requires firms to reveal directorships in publicly traded companies, 6 many proxy statements include additional biographical information about director nominees including other nonpublic directorships. 7 Therefore, we calculate the number of directorships using two different methods. In the first one, we include all directorships 6 Pursuant to Item 401(e)(2) of Regulation S-K, firms are required to Indicate any other directorships held by each director or person nominated or chosen to be a director in any company with a class of securities registered pursuant to section 12 of the Exchange Act. 7 For example, many firms will list non-public and foundation directorships in the biographical information required for each director in the proxy statement. 8

12 in public and nonpublic companies listed in the proxy statement, but excluding directorships in charitable organizations, foundations and other clearly nonprofit firms. This number includes an executive s directorship in his or her own firm (the sender firm), but excludes the new appointment. We call this variable forprofit. In panel A of table 1, we report that the average new appointee already holds 2.24 directorships. Alternatively, we count only the number of directorships held in publicly traded firms 8 outside the sender firm. 9 Using this second definition of directorships, which we call directorships, we find that the average individual only holds 0.97 outside directorships. Approximately 10% (25%) of the events involve individuals that hold 3 (2) or more outside directorships in publicly traded firms, however 20% (62%) of the individuals hold 3 (2) or more directorships in for-profit companies. We find that 16% of the individuals become directors of a receiver firm without holding any other directorship in a for-profit firm, and 46% do not hold any additional outside directorships in publicly traded firms. For the remainder of this paper we focus on the variable directorships as our measure of outside directorships held by the individual because firms are only required to report the other publicly traded directorships held by directors or nominees. However, if we use the variable forprofit in our analysis, similar results obtain We call a firm publicly traded if it has information listed on CRSP. The match is based on the name of the company listed in the proxy statement or news announcement. 9 We exclude the sender firm directorship from directorships because this way our two-stage regressions in a later section will not be biased nor require a re-definition of the variable at that point. 10 It is interesting to note that the fact that firms may report more than required did not alter the conclusions of the study. In particular, the difference between forprofit and directorships as a separate variable never significantly affected the CARs, although the results are more significant using the forprofit instead of the directorships variable. 9

13 3 Shareholders Reaction to Appointments 3.1 Univariate Results To examine the impact of an appointment on the value of sender and receiver firms, we perform an event study using the earlier of the news announcement date or the proxy filing date. We compute cumulative abnormal returns (CAR) over the threeday window [-1,1], following the standard event-study methodology of Dodd and Warner (1983) and Brown and Warner (1985). The market model parameters are estimated using the days [-250,-20] before the event date. We exclude five receiver firms from the event study due to either missing returns data in the window [-1,1] or less then 100 observations in the parameter estimation window. We use an equally weighted average return including distributions as our benchmark. The significance levels are computed using the cross-sectional standard deviation of the CARs (p 1 - value). We also report the significance levels based on the standardized prediction error (p 2 -value), using the time-series of abnormal returns prior to the event, separately, if they differ from the cross-sectional results. Medians are tested using the Wilcoxon rank-sum test, and proportions are tested using a binomial test. The cumulative abnormal returns (CAR) over the announcement window of [-1,1] are significantly negative for both sender and receiver firms as shown in panel A of table 2. The average (median) announcement CAR for the sender firm is 0.41% ( 0.52%), which is significantly different from zero at the 10% (5%) level. Only 41.7% of the events have a positive CAR. Economically, the dollar loss to the average (median) sender firm is $33.9 ($3.51) million. For the receiver firm, we find an average (median) drop in shareholder value of 0.46% (0.49%) or $55.7 ($5.08) million, both marginally significant at the 10% level. Our event study results for the receiver firms differ from the results reported in Rosenstein and Wyatt (1990) and Ferris et al. 10

14 (2002), but are consistent with Rosenstein and Wyatt (1994). Our sample is comparable to the sample used in the latter study in that we require the new director appointees to be affiliated with a publicly traded sender firm. If we relax this requirement, we find an insignificant CAR of 0.21% for our entire sample of 471 events (not shown). 11 Under the assumption that individuals trade off the personal benefits of accepting an outside directorship 12 with the costs, the results are consistent with the existence of agency problems because, on average, shareholders do not welcome these decisions. We next turn to our main question of whether the sender firm CARs differ once we condition on the number of directorships an individual already holds. Panel B of table 2 shows that the announcement of the first outside directorship in a publicly traded firm is already bad news for the sending firm shareholders. We find an average CAR of 0.89%, which is significantly negative at the 1% level. The average CARs for events where the new appointee already holds other outside directorships in publicly traded firms are mostly negative but insignificant. The conclusions are similar if we use the variable forprofit that includes the directorship in the sender firm as well as directorships in private firms. These findings seem to be at odds with the signaling hypothesis and the argument that outside directorships are an effective place of learning for the executive. While the sender firm CARs are generally negative, the hypothesis that executives are too busy to take on an additional outside directorship predicts a negative relation between directorships and CAR. The prediction is based on the assumption that an 11 An additional difference to the work of Rosenstein and Wyatt (1990, 1994) is that we use the earlier of the proxy filing and news announcement date. We also do not exclude events with contaminating information related to the receiver firm. Excluding the 18 events with contaminating news about the receiver firm in the announcement window the average CAR is 0.45%, significant at the 10% level. Concentrating on the events where the announcement date is before the filing date we find an average CAR for the receiver firms of 0.42%, which is significant at the 10% level (127 events). 12 Outside directorships can be the source of prestige and valuable contacts according to Mace (1986). 11

15 executive s time exhibits decreasing marginal returns. In other words, if an executive spends 12 hours per day working for his main employer and now reduces his work hours by one hour because of the outside directorship, this reduction is less costly to shareholders than an executive reducing his work hours from 11 to 10 due to a second directorship. However, as shown in the first regression in table 3, we do not find a significant relation between the number of directorships and sender firm announcement returns. This result is consistent with the interpretation that shareholders of sender firms do not care about the number of directorships. It is also possible, however, that the number of directorships proxies for both a signal of higher managerial quality as well as a busier executive, in which case the coefficient could be the average of the positive and negative effects. To distinguish between the two interpretations and further investigate our hypotheses, we use a multivariate analysis in the next section. 3.2 Multivariate Analysis In this section we refine our tests using the insights from Smith and Watts (1992), Fama (1980), and Fama and Jensen (1983) Investment levels and opportunities First, we split our sample of events into subgroups based on proxies for growth opportunities and the number of directorships. We hypothesize that firms with greater investment activities or growth opportunities require more attention and time commitment by the executives of the firm. If executives of these firms accept additional outside directorships, we expect to find a negative relation between the CAR and the number of directorships. On the other hand, individuals of firms with low growth opportunities may wish to signal managerial quality by taking on additional outside directorships because they find it more difficult to signal quality with investment 12

16 decisions. This would result in a positive relation between the number of directorships and investor reaction for low-growth firms. As a proxy for the growth opportunities or investment activity of the sender firm, we use both the ratio of capital expenditures to assets (Capex) and the market-to-book ratio (MB). The results reported in panel C of table 2 support our hypotheses the firms with above sample median growth opportunities lose significantly more value when executives already serving on two or more outside boards accept outside directorships. 13 Using Capex (MB) as a proxy for growth opportunities, we find a significantly negative average CAR of 1.97% ( 1.35%). The CAR for this group is significantly lower than for the group with high growth opportunities (Capex; MB) but less than two outside directorships ( 0.55%; 0.44%); low growth opportunities and less than two outside directorships ( 0.16%; 0.34%); and low growth opportunities and two or more outside directorships (0.64%; 0.52%). Consistent with the signaling hypothesis, the positive number for the last group indicates that shareholders react favorably to the announcement of a nomination of one of their executives if the firm has below-average growth opportunities and the executives already holds two or more outside directorships. To further test the hypotheses and analyze the cross-sectional differences, we estimate the following multivariate regression: ( Directorships GrowthD) + λ ε CAR = α + β Directorships + γ GrowthD + δ X + (1) where CAR is the cumulative abnormal return of the sender firm around the announcement that an executive or Chairman of that firm joins an outside board; Directorships is the number of outside directorships currently held by the executive; GrowthD represents a dummy variable equal to one when the sender firm s growth 13 Similar results obtain if we stratify the sample by above versus below industry-median MB. Results are not shown. 13

17 opportunities are above the median level of growth opportunities of our sample of sender firms and equal to zero otherwise; and X represents a vector of other control variables described below. A positive β would be consistent with the signaling hypothesis, assuming that a higher number of directorships is more difficult to obtain and the signal of accepting an outside directorship becomes stronger the more directorships an individual holds. An extension of the argument suggested by Smith and Watts (1992) would predict a negative δ and the sum of β and δ to be negative. Table 3 presents the multivariate regression results. We report coefficients of ordinary least squares regressions with p-values based on White-adjusted standard errors. The dependent variable is the sender firm s cumulative abnormal return over the event window [-1,1]. Model 2 shows a β of which is significant at the 5% level, indicating that low-growth sender firms benefit from the announcement that one of their executives joins another board. High-growth firms, however, display a negative relation between the number of directorships and CAR. The coefficient on δ is and significant at the 5% level. Further, the sum of β and δ is also negative and marginally significant. These findings are consistent with the interpretation that executives of high-growth firms are becoming too busy when accepting additional outside directorships. The cost to the shareholders appears to outweigh the benefits in those firms. In model 3 we also include a set of control variables. To control for potential agency problems at the sender and receiver firms, we include dummy variables for sender firms with less than a majority of independent directors [ not independent or NISBD] (e.g. Weisbach, 1988); for receiver firms where the CEO is on the nominating committee [CEO is nominating in receiving firm] (e.g. Shivdasani and Yermack, 1999); and if the sender and receiver firms have interlocking board members, i.e., either a 14

18 common director, an executive of the sender firm on the receiver firm s board or vice versa [Interlock dummy] (e.g. Hallock, 1997; Fich 2000). We find nearly 60% of the sender firms do not have a majority of independent outside directors, the CEO is on the nominating committee in 57% of the receiving firms, and 21% of the events already have a board interlock. We also control for prestige of the new directorship by including the industryadjusted MB of the receiver firm [Industry-adjusted MB receiver] and a dummy equal to one if the receiver firm s market capitalization is greater than the market cap of the sender firm [relative size dummy]. We include dummy variables to control for the possible influence of directors from the financial service industry, defined as firms in the one-digit SIC of 6 [Financial receiver and sender dummy] (e.g. Booth and Deli, 1999; Kroszner and Strahan, 2001; Kracaw and Zenner, 2000). In our sample, we find that 16% (15%) of the receiver (sender) firms are financial firms that operate in the one-digit SIC of 6. We also control for potential size effects of the sender with the logarithm of sales [sender log sales] and previous performance of both sender and receiver firms, using industry-adjusted stock returns over the period starting 250 days prior to the event until 20 days before the event [Prior industry-adjusted stock return]. The prior stock return as well as the industry adjusted MB of the receiver firm may also represent the time commitment associated with the new directorship. We expect that receiver firms with poorer prior performance require a greater commitment to monitor. For the same reason, we also include a dummy variable equal to one if the board of the receiver firm has met more than seven times (the median) in the previous fiscal year [Board meeting dummy] (Vafeas, 1999) 14. Finally, we also control for industryspecific human capital of the director appointment by including a dummy equal to one 14 Qualitatively similar results obtain if we use the continuous variable. 15

19 if the sender firm and receiver firm operate in the same 2-digit SIC [Same 2-digit SIC dummy], which occurs in 8% of the firms. When we include these control variables in the remaining models reported in table 3, the interpretation of β and δ remains unchanged as shown in model 3. We find that sender firm shareholders react more negatively to the announcement of the additional directorship when the sender board is not independent and when the prior performance of the sender firm is stronger. These results are consistent with agency problems associated with weaker monitoring or less powerful boards in the sender firms. In section we will further investigate this issue. We also find that the announcement return is higher when the sender and receiver firms are in the same 2-digit SIC code and when the receiver firm has a higher industry-adjusted MB. These results are consistent with low-performing receivers requiring more attention and with sender firms benefiting from potential industry-specific knowledge transfer between the two firms. All of the other control variables are insignificant Further refinements In the previous section we found support for both hypotheses. Executives of highgrowth firms hurt shareholders by taking more outside directorships, possibly because they are getting too busy. We also found support for the signaling hypothesis in firms with low-growth opportunities where executives might find it more difficult to signal quality through investment activities. We further test the busy hypothesis following the arguments suggested by Smith and Watts (1992). If a CEO s time spent at the sender firm is more valuable than the time of other executives or the Chairman, then in high growth firms the position of CEO should be associated with a more negative relation between the CAR and the number of directorships. 16

20 We also expect the signaling hypothesis to be particularly important for younger and/or non-ceo executives, given that their track record is shorter and it may be harder for the market to correctly evaluate their managerial ability. To test these extensions, we use the following framework: CAR = + δ 2 α + β Directorships + γ GrowthD + δ1 ( Directorships GrowthD) ( Directorships GrowthD CEO) + δ ( Directorships Age < 62Dummy) + λ X + ε 3 (2) where CEO is a dummy equal to one if the individual holds the title of CEO in the sender firm, 15 and Age<62 Dummy is a dummy equal to one if the individual s age is less than 62. If CEOs are particularly important and his or her time most valuable to the sender firm, then we expect δ 2 and the sum of β + δ 1 + δ 2 to be negative. The signaling hypothesis predicts δ 3 and β + δ 3 to be positive. Model 4 in table 3 shows the results. We find a δ 1 of , significant at the 5% level and a δ 2 of , significant at the 10% level. The sum of β + δ1 and β + δ 1 + δ 2 are significantly different from zero at the 10% and 1% level, respectively. This indicates that individuals from high-growth firms are associated with a more negative shareholder reaction the more directorships they hold, and the loss in value is even greater when the executive accepting the additional appointment is also the CEO of the sender firm. The signaling hypothesis also finds some support in this test. Although in model 4 the coefficients on directorships and the interaction with the age<62 dummy are insignificant, the sum of the two coefficients ( β + δ 3 ) is significant at the 10% level. This result suggests that the signaling aspect of an additional directorship is more important for younger executives. 15 We find similar, but statistically less significant, results if we replace the CEO dummy with a dummy equal to one if the individual holds the position of CEO and/or Chairman (not shown). 17

21 3.2.3 Robustness Tests In model 6 we show that the results are robust to using the MB ratio as a proxy for growth opportunities. High growth firms are those with a MB ratio above the median ratio for firms in the sample. 16 If we interpret the market-to-book ratio as a proxy for the quality of management, our results suggest that the shareholders reaction is more negative the more outside directorships a high quality executive accepts. We believe this interpretation to be consistent with our hypothesis that those individuals are too busy, and the costs of accepting an additional outside directorship outweigh the benefits. Alternatively, this loss in value is consistent with a prior overvaluation of high market-to-book firms. The nomination of the firm s manager to an outside board may draw greater scrutiny to the firm and result in a negative adjustment to firm value. While we have used a continuous variable for the number of directorships held by an individual, we now show that the interpretations do not change if we use a dummy variable equal to one if the individual already holds two or more outside directorships prior to the new nomination [Many dirshps]. We use this cut-off based upon the recommendations of the NACD (1996) and the CII (2002). 17 In models 5 and 7 we report the results using Capex and MB as the proxy for growth opportunities, respectively. In model 5, for example, we find that individuals with two or more outside directorships working for a low growth company do not significantly affect shareholder value at his or her main place of employment when accepting another directorship. However, in high-growth firms such individuals negatively affect shareholder value by = , or 2.3%. High-growth firms with CEOs having two or more directorships are associated with a further drop in shareholder value of 0.92% for a total of 3.28% ( 2.3% 0.92% = 3.28%). This sum is significantly different from 16 In untabulated results, we also find similar results using the industry-adjusted MB ratio, where highgrowth firms are those with a positive industry-adjusted MB ratio. 17 Similar results are found using a cut-off of three or more outside directorships (not shown). 18

22 zero at the 1% level. On the other hand, low-growth firms with individuals under 62 having two or more directorships are associated with a marginally significantly positive CAR when accepting an additional directorship ( = or 0.56%). While this last finding is consistent with the signaling hypothesis it could also be interpreted as evidence for agency problems if individuals closer to retirement have different career concerns affecting the level of perquisite consumption (Fama, 1980; Brickley, Coles, and Linck, 1999). In the next section we further investigate this agency interpretation Agency Problems Hermalin and Weisbach (1998) present a model of a bargaining process determining board composition where the proportion of independent directors is negatively related to the power held by the CEO. We predict that executives can more easily consume perquisites in the form of outside directorships in firms with less powerful boards than in firms with better monitoring by the board (e.g., Weisbach, 1988; Brickley, Coles and Terry, 1994). Thus, we expect a more negative CAR for sender firms without an independent board unless the market already discounts the value of such firms. Alternatively, a firm with fewer outside directors might want to attract more outside directors. If the market for board members is an in-kind barter market (e.g., Lorsch and MacIver, 1989), then taking on more outside directorships could be positive news for shareholders. In table 4, we report regression results for the following equation: CAR = + δ 2 α + β Directorships + γ Agency Pr oxy + δ1 ( Directorships Agency Pr oxy) ( Directorships Agency Pr oxy CEO) + δ ( Directorships Age < 62Dummy) + λ X + ε 3 (3) where Agency Proxy is either a dummy equal to one if the sender board is not independent [NISBD] or the nominee holds less than the sample median ownership in the sender firm. Ownership information is collected from the proxy statements and 19

23 includes stock and options held in the sender firm. The average (median) ownership in the sender firm of a nominee is 11.9% (0.8%) as shown in table 2. We find a greater loss in shareholder value associated with additional directorships for sender firms without a majority of independent directors. We still find a marginally significantly positive relation between CAR and young individuals that hold more outside directorships. For robustness, we estimate a second model where we replace the independent board dummy with an ownership dummy equal to one if the individual s ownership in the sender firm is below the median ownership of the sample nominees. We find that our conclusions do not change, and the results are consistent with greater losses to shareholders of sender firms with weaker managerial incentives. In sum, we find a negative relation between the number of directorships and the announcement return associated with executives of high-growth firms accepting an additional directorship. On the other hand, evidence in favor of the signaling hypothesis, while in the expected direction, is weaker. 3.3 Two-stage regression Given the weak evidence in support of the interpretation that the number of directorships is a signal of quality, the question arises whether we have appropriately accounted for the market s expectations about the number of directorships an individual will accept (or that the director will be offered). In this section we use a two-stage regression approach in order to control for market expectations related to the announcement of a director appointment. The first stage regression is a Poisson maximum likelihood model with independent variables closely related to those used by Booth and Deli (1996), Shivdasani and Yermack (1999), and Ferris et al. (2002). The sample for the first stage regression is based on the sample of firms covered in the 20

24 IRRC database and Compact Disclosure. Details of the sample selection are reported in the Appendix Empirical Results of the First-Stage Regression The results of the first-stage Poisson regressions are reported in table 5. We find that individuals hold more directorships if they are older and if they hold the position of Chairman or the double position of CEO and Chairman. The number of additional directorships is also positively related to the size of the sender firm, the number of independent directors on the sender firm s board, and the market-to-book ratio of the sender firm. Non-CEO executives and individuals from financial institutions hold significantly fewer directorships. Our results are generally consistent with the results reported by Booth and Deli (1996) for a sample of firms in and with Ferris et al. (2002) for a sample of firms in Although Booth and Deli find a negative association between the market-to-book ratio and the number of outside directorships held, we find a positive relation for our sample which is also consistent with Ferris and Jagannathan (2001) using 1995 data. 18 Since the market-to-book ratio can proxy for growth opportunities as well as the market s assessment of the managerial quality, we estimate a second regression and include the ratio of R&D to sales to represent growth opportunities and ROA as a measure of performance. 19 We find an insignificant negative coefficient on the R&D to sales variable and a significant positive coefficient on ROA. Since ROA was insignificant in the market-to-book regression, it is possible that the positive coefficient on the market-to-book ratio in model 1 reflects performance rather than 18 We also employ a Tobit regression as in Booth and Deli (1996) and find a positive coefficient on the market-to-book ratio, as shown in the third regression in Table For firms with a missing value of R&D, we assume that they have the industry average R&D, measured at the 2-digit SIC level. We do not use a long-term performance measure of ROA as in Brickley et al. (1999) because we do not know for how long the individual has already been with the current employer. 21

25 growth opportunities, which would be consistent with prior research suggesting that managers with stronger prior performance receive more opportunities for outside directorships Empirical Results of the Second-Stage Regression The second-stage regressions reported in table 6 are similar to those reported in table 3, except directorships is replaced with a variable that adjusts for the expected number of directorships using the results from the first-stage Poisson model with the market-to-book specification regression. 20 The expected number of directorships held by an individual is called E(Directorships) and is computed as follows: E(Directorships) = exp( ˆ' β x), where x is the vector of variables used in the first-stage regression, and βˆ is the coefficient-vector of the Poisson maximum likelihood regression. 21 The coefficient on our proxy for excess directorships is positive and marginally significant, suggesting that executives can signal quality by accepting more than the expected number of directorships. However, we continue to find a significant negative relation between the excess number of directorships and the CAR for sender firms with greater growth opportunities, even after correcting for the expected number of directorships. These results are consistent with agency problems in the sender firm because the executives are accepting additional directorships at a significant cost to shareholders. We also find more direct evidence of agency problems in the third regression where the excess number of directorships held by executives in firms without a majority of independent directors is negatively related to the CAR. Overall, our results from the two-stage regressions suggest that although individuals can signal 20 We obtain similar results if we use the specification with the R&D/Sales ratio or if we use the Tobit specification (not shown). 21 Qualitatively similar results obtain if we round E(Directorships) to the closest integer value. 22

26 their quality by accepting more than the expected number of additional directorships, executives in high growth firms and firms with weaker boards do so at the expense of the shareholders. 3.4 A diversified shareholder s point of view Our tests thus far have focused on the sender firm s shareholders. One reason we have done so is that it is easiest for those shareholders to restrict their executives from taking on too many directorships or directorships that would seem to draw attention away from the sender firm. However, research has shown that outside directors potentially benefit the receiver firm s shareholders (e.g., Baysinger and Butler, 1985; Weisbach, 1988; Byrd and Hickman, 1992; Rosenstein and Wyatt, 1990; Shivdasani, 1993; Brickley, Coles, and Terry, 1994; Cotter et al., 1997). If acquiring board room talent reduces sender firm shareholder value because of the divergence of executive effort, the receiver firm where the executive joins the board should benefit. It is therefore important to study the impact of the number of directorships on all firms that compete for the time and effort of the individual directors (the receiver firm, the sender firm, and all other public firms where the executive serves on the board). This leads us to the final question of whether a diversified shareholder should care. On one hand, a diversified shareholder might lose in the sender firm as shown above, but gain from the addition in the receiver firm. On the other hand, announcement returns could be positively correlated across sender and receiver firm, especially with respect to a higher number of directorships. We first investigate the individual announcement returns for sender and receiver firms. Of the 211 events where we have sender and receiver CARs, 78 (37%) are both negative and 46 (22%) are both positive. The remaining 41% have either a positive sender or receiver CAR, but not both. This suggests that some diversification might be 23

27 possible. However, if we compute the significance of each individual sender and receiver CAR requiring a p 2 -value of 5%, we find only symmetric announcement returns on the sender and receiver firm. We test three different regression specifications, each with a different dependent variable. First, we run a regression with only the receiver firm CAR as the dependent variable. Second, we discuss the results of a regression that has CARs from the other firms, i.e., those firms where the individual already sits on the board prior to the new appointment. Finally, we form a market-value-weighted portfolio of CARs using the sender firm, the receiver firm, and any other firm where the executive sits on the board. In each of these specifications our definition of GrowthD is based on the market-tobook ratio of the sender firm, and we include the full set of control variables discussed earlier in addition to a dummy variable equal to one if the receiver firm s board does not have a majority of independent directors Receiver Firms In model 1 of table 7, we find that receiver firm CARs are negatively related to the number of other directorships help by the new director if the individual is from a low-growth firm. This result suggests that a higher number of directorships are not interpreted as a positive signal about the quality of the director, but rather as negative news consistent with a story that these individuals are busier and will be able to devote less attention to monitoring the receiver firm. For new directors from high-growth firms, there is no significant relation between the number of directorships and receiver firm CAR. Again, the market-to-book ratio might proxy for managerial quality instead of the business of the executive s main job. If that was true, we should observe a more positive relation for CEOs, assuming their impact on the market-to-book ratio is bigger than for the non-ceos. However, if the 24